Pensions

Should you ditch your final salary pension scheme?

We presently find ourselves in a very unique market, one that offers us a simply life changing amount of money, both for us and our family. Many pension providers across the country are offering very large enhanced pension transfer values for members to leave their final salary schemes. For years they have been referred to as ‘gold plated’ schemes, and they still are, but not for the potential lump sum value now, rather than the income forecast.

The regulators themselves understand the importance of obtaining proper financial advice when looking at these schemes. They have imposed legislation stating that any pension over £30,000 must obtain advice before transferring. But what are the potential pitfalls?

Let’s assume someone had been offered £10,000 per annum from his or her current pension at the age of 65, and they are currently 50-years-old. If a pension company offered them a transfer value of £200,000 to leave the scheme, you would struggle to justify leaving said scheme given that there is a good chance of surviving over 20 years. Whilst there are scenarios where the life firm are not be able to pay the income, it is exceptionally unlikely, and it’s close to a cast iron guarantee. That being said, if the offer was £400,000 then it would look very different.

The risk is working out somewhat the morbidly unknown, what age will we die? A financial adviser will run national statistics, alongside your financial planning to ensure you’re in the best possible position. The process is to meet and discuss what your retirement aspirations are; higher income, more tax free cash, fixed income, to leave money to your children to name a few. They will then be able to liaise with your pension provider to breakdown what suitable options you have available to you. Should a transfer not be viable there wouldn’t be a fee due*.

Continuing on from the £400,000 offer, assuming all parties involved were happy this would be transferred into a personal pension (There is zero tax charge to transfer a pension). Now, in the case that this person is only 50-years-old, and their previous pension was set to pay out at 65, which means that they would have 15 years of growth potential on their £400,000. Over the medium to long term, many advisers will either compound 4% or 5% growth to project what the vale could look like at 65. Assuming 4% initially, your pension pot would be valued at £720,377 or £831,571 at 5%.

It’s imperative to look at sustainable income when addressing final salary transfers, and your adviser will of course ask you what your target income goals are, before conducting analysis. A risk in the transfer is of course that the pot runs out, which is why vast precautions are taken. Most clients will wish to take the maximum tax free cash from their plan, which based on the above figures could be either £207,892 or £180,094. This is simply tax free monies which can be spend / invested / saved as you please.

Often you would judge the income on the same basis of 4 or 5% too:

£720,377 – £180,094 = £540 283 @ 4% income p/a = £21,611.32

£831,571 – £207,892 = £623 679 @ 5% income p/a = £31,183.88

As you can see, investment markets can heavily dictate what the income can look like, and the above are simply projections based on fairly current case studies. What can we compare here though is that the income projected far out weights the initial final salary offer, which is one of the criteria that both yourself and your adviser will look for.

This of course is based on someone that wishes to have a fixed income band for life, however you may decide that you wish to have a higher income in the early years and reduce it after 10 years, after you’ve enjoyed some dream holidays and paid off the last section of your mortgage. The risk here is in a downturned market where the portfolio may drop by 5% and you’re taking 6% income, this will have a larger impact on your holdings. When you’re saving, this is known as pound cost averaging, however when your pension is being taken in drawdown, it’s known as pound cost ravaging. In extreme circumstances, this could have a very damaging effect on how long the pot will last for you.

Moving away from statistical projections, there are further benefits of a personal pension. Upon death in a final salary scheme, your surviving spouse will only receive 50% of the agreed income (£5,000), and then on second death the plan is finished. Interestingly, under a personal pension arrangement the income can continue at the same rate, and on second death the remaining pension value can be passed down to your children nil of tax.

Inflation is a factor that shouldn’t be ignored as it will have an effect on each of us, as we are currently at a near four-year high of 2.9%. Investment returns aim to mitigate the effects of inflation by beating this figure on a consistent basis. You will have at least one meeting a year with your adviser whom will explain the performance of your holdings, effects of economic changes, taxation and of course inflation. Given that the world changes each and every day, it’s invaluable to have an adviser that is looking after each and every cause and effect to you personally.

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