A final salary pension, also called a Defined Benefit (DB) pension, is one of the most common and valuable types of pension in the UK. It is typically built up while working for a UK employer, with contributions from you, your employer, and government tax relief. Unlike pensions that depend on investment performance, a Defined Benefit pension guarantees you an income for life based on your salary and years of service.
In our video below, Cameron James CEO and Independent Financial Adviser, Dominic James Murray, gives you the Defined Benefit pension transfer advice you've been looking for. Including how DB transfers work, when a transfer might make sense, and the factors to consider before making the move.
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Defined Benefit Pension Transfer
You can transfer a final salary pension to a fixed-size pension pot, such as a defined contribution plan. This process is called a defined benefit pension transfer or a final salary pension transfer.
In a defined benefit pension transfer, your provider may offer you a lump sum in exchange for giving up your guaranteed pension. This is not paid as cash but as a Cash Equivalent Transfer Value (CETV), which you can place in a pension pot to draw an income from once you reach age 55.
Benefits of Final Salary Pension
If we look back 10-40 years, the final salary pension would, in time, have increased significantly, and it would have been one of the pensioners' most precious assets. They have risen in popularity because final salary pensions have several advantages as well.
Safe
All defined benefit schemes are protected by the Pension Protection Fund (PPF). However, the PPF may have a limitation on how much it can guarantee.
If you are past your normal pension age or start receiving your pension early due to illness, you receive a full PPF pension. Anyone receiving a survivor's pension, such as a widow’s or widower’s pension, also receives full cover.
If your employer went bankrupt, and you were under your regular pension age, you are entitled to a pension equal to 90% of the amount you had saved. This is subject to a government-imposed upper limit. For example, the cap from 1 April 2021 to 31 March 2022 for a 65-year-old is £41,461.07 (PPF). Apart from this, you also have indexed linking, which implies that the investment's annual growth is secured.
Lengthy Period of Time
A DB pension guarantees benefits for the rest of your life. You will receive pension income for as long as you live, provided the pension plan remains funded.
Death Benefits
In the case of your death, your spouse or beneficiaries will get half or a certain percentage of your pension fund at your normal retirement age.
Disadvantages of Defined Benefit Pension
Despite the advantages of a DB pension, there are certain drawbacks you may encounter in the future. Here are some reasons why some final salary pension holders think about transferring their pensions.
Limited Control
A final salary pension is less flexible than a defined contribution plan in several aspects. You cannot vary the amount of income you receive from it, nor can you withdraw greater lump sums you are constricted to the 25% PCLS lump sum for a reduced annual income.
Unadjusted Risk Profile
The profile of one pension holder may be substantially different from that of another. Some of our clients, for example, may have other considerable wealth and are eager to maximise the pension pot and take full advantage of tax-free growth instead of playing it safe. While some of our other clients may want to err with caution and preserve the value of their pension pot. Their pension pot may be one of their few assets, and they want to be extremely conservative with it.
Currency Risk
For instance, you have a UK final salary pension while living in the US, all of your pension and retirement income may be in US dollars. If this is the case, having a UK pension in Pounds exposes you to currency risk.
Beneficiaries
Your beneficiaries will not be able to inherit a final salary pension. If you die early, your spouse may receive a widow’s pension. However, most of your benefits will be lost, and your children will not inherit anything. This is one of the most important reasons why some people choose to transfer their pensions.
Beneficiary Benefits Before and After Transferring a DB Pension
In a DB scheme, a beneficiary can only receive 50% of the fund value from the pension holder’s pension pot. One of the primary causes, as previously stated, people choose to perform a DB transfer is because after they complete the transfer, they may pass on 100% of the value to their beneficiary. It is not limited to their spouse. They can pass their pension on to their partner, children, or anybody else they want.
Beneficiary Benefits Before DB Transfer
Let's look at an example.
You have £300,000 in your pension pot and receive an offer of £10,000 a year. If you die two years before retirement, your spouse receives a lump sum under the scheme rules, usually two to four times your final salary. In this case, that could be £200,000.
Let’s say you passed away 10 years after retirement as a pension holder. Your spouse would typically receive a reduced annual pension income from the scheme based on the rules, typically up to 50%, therefore may be £5000 every year in this case. If the widower dies, the pension pot will not pass on to the beneficiaries.
Beneficiary Benefits After DB Transfer
Let's say that you decide to transfer your Defined Benefit pension into International SIPP. If you die after completing a DB pension transfer, your beneficiaries receive 100% of the total pension fund. If your pension pot is worth £300,000, or you've been withdrawing £10,000 for the past 5 years, your beneficiaries can still get another £250,000. In this case, you also have the option of making multiple payments to different beneficiaries.
So, Who Should Transfer?
When you transfer to a defined contribution plan, you give up a guaranteed income for life, which often increases to protect against inflation, in exchange for a future income that you cannot predict with certainty. You must decide if you qualify to transfer your pension.
Transferring might NOT be suitable for you if:
- A final salary pension is your only retirement asset
- You have limited capital
- You have high outstanding mortgages
- You have few property assets
Transferring might be suitable for you if:
- You have a high asset outside a UK DB pension
- You want to maximise your pension
- You don’t need guaranteed income
We have a thorough discussion regarding all considerations to transfer out your Defined Benefit pension here.
Get Your Best Pension Transfer Advice at Cameron James
Transferring your final salary pension is a permanent and life-changing decision. Once you transfer out, there is no going back, so it is vital to make the right choice the first time. If your DB pension is worth more than £30,000, UK law requires you to get advice from an FCA-regulated adviser before proceeding.
At Cameron James, we specialise in guiding clients through the complex decision-making process of a Defined Benefit pension transfer. Our advisers will help you understand whether transferring is in your best interest, ensuring you have complete clarity before committing.
Your first consultation is always free, so there is no cost to explore your options.
Book your free consultation today and get expert, impartial advice on your Defined Benefit pension transfer.