A clear demand to cash in defined benefit pension schemes has been observed, following the introduction of pension freedoms. The sudden spike in those seeking to bank their final salaries is at a time where the value of transfers is at an all-time high.
Starting at age 65, a member of the defined benefit (DB) scheme, currently due an annual pension rate of £10,000, could usually expect a transfer amount of £243,000 according to the Xafinity Transfer Value Index.
Pensions are largely invested in bonds, the yields from such have recently dropped. This has resulted in transfer values rising substantially, as a larger amount is required in order to produce the same level of income.
One of the factors fuelling the increase in DB schemes becoming ‘cashflow negative’ has been the increase in transfer activity, according to actuary, Hymans Robinson. This refers to plans where the money coming in through contributions is less than that going out.
A rise in demand to opt for defined contribution schemes or cash lump sums over final salary schemes has also been observed by a Metlife report. 31% of the over-40s surveyed who had DB schemes said they would be tempted by the increased transfer values pension schemes had to offer.
Wealth Management Director at Metlife UK, Simon Massey emphasised that “there is a real risk people will regret giving up the security of a guaranteed income for non-guaranteed options”.
For those without other resources in retirement, the DB pension income may be essential to fund their care fees. The benefits are often therefore, not worth giving up.
For inheritance tax planning, transferring may be a worthwhile option for those who have other assets and are thus able to produce retirement income.
Recognising that this may have been a reason for the rise in final salary scheme swaps, was Joe Sanders. The Chartered Financial Planner at Informed Financial Planning stated: “A spousal income is built into most defined benefit schemes. Typically, a spouse would inherit 50% of the member’s income. Some defined benefit schemes also offer a legacy income to dependent children.
“For some this is a valuable option, but it could potentially be a poor return compared to inheriting a lump sum from a defined contribution scheme – a tax-efficient way of leaving a legacy.
“The death benefits of a DB scheme are extremely rigid, and if a client is not married and has no financially dependent children, the fund may die with them. If they want someone else to inherit their fund, I usually advise them to move it into a defined contribution scheme.”
There may be barriers to obtaining the money in practical terms. It may also be difficult to gain financial advice on an independent basis, the standard which is required by the law if the pension transfer value is over £30,000.
