Transfer final salary pension to private pension

I think this one sits alongside WG Grace's thoughts on winning the toss in cricket. For keeping the final salary scheme, see the word bat.

When you win the toss – bat. If you are in doubt, think about it, then bat. If you have very big doubts, consult a colleague – then bat.

dunstonh wrote: »

I cant see it because of paywall but I'm surprised they wasted article space on it.

STAFF approaching retirement are being tempted with incentives designed to cut their employers’ pension bills that could leave someone with a £20,000 a year payout more than £240,000 worse off.

Almost every large employer running a final salary pension scheme is looking at ways to reduce costs. There are 1.6m workers paying into final salary schemes in the private sector. Only 13% of schemes are still open to new members, according to the National Association of Pension Funds.

Firms such as ITV and Boots are among those to have made offers to pensioners to buy out inflation-linked increases to their pensions. BT is also offering those at retirement the opportunity to swap pension upratings for a higher initial payout.

Such a move might sound tempting to employees, but a period of higher-than-expected inflation could substantially reduce the value of their pension in real terms.

The move can save companies a fortune. In its 2010 annual report, ITV disclosed that it had pocketed £38m from the exercise.

Figures from Hymans Robertson, the pensions consultant, show that someone in a final salary scheme due £20,000 in retirement, who took a higher £26,000 payout in return for no annual increases, could be £240,000 worse off if inflation averaged 5% over the following 22 years.

A code of practice was launched last year imposing restrictions on these types of pension incentive programmes after widespread criticism that workers were being encouraged to make poor decisions.

The code, though, applies only to pensioners and to current or former employees. Those approaching, or at, retirement are exempt, making them an attractive target for employers.

How workers are being targeted

Workers nearing retirement in final salary schemes get a statement outlining what they will receive by way of pension. This paperwork also normally includes information about how much they can take as a tax-free lump sum, and how much their pension income will fall if they choose to take it.

Increasingly, pre-retirees are being offered two further choices. The first outlines the range of options available if they take their pension pot elsewhere, transferring it out of the employer’s scheme. This would typically involve transferring it to a less generous scheme for a short-term gain.

The second gives the terms available if they surrender all annual pension increases accrued before 1997, so their income will not keep pace with rising prices.

Alistair Russell-Smith of Hymans Robertson, the pensions consultancy, said: “Most big companies are looking at ways to minimise pension liabilities. We expect renewed activity primarily targeting the at-retirement group.”

Advisers said anyone approaching retirement should view such deals with extreme caution.

Laith Khalaf of Hargreaves Lansdown, the adviser, said: “You have to ask yourself why the company is suddenly offering all these new alternatives. The starting point must always be that giving up a guaranteed, inflation-linked pension, providing security for a surviving spouse, is a bad idea.”

Giving up inflation-linked increases

The average life expectancy for a man retiring at 65 today is a further 22 years, by which time the buying power of any pension will have roughly halved if inflation averages 2.5%. For this reason, surrendering annual increases is a high-risk strategy.

However, the chance to have a greater amount of ready cash in the early days of retirement can be attractive.

For example, someone heading for a £20,000 a year escalating pension could swap that for an income of £26,000 that never goes up.

This would prove a smart move in the event that inflation remains lower than currently expected — say 1%, rather than 2.5%, for the next 22 years. In that case, the pensioner would be £80,000 better off over the course of retirement. If death comes after 10 years of retirement, an extra £40,000 would be pocketed.

Yet it is much more likely that inflation will be higher than expected.

If the cost of living increases by 5% rather 2.5%, the pensioner will have lost a total of £240,000 by the age of 87, according to Hymans Robertson.

Even if inflation remains muted, a pensioner living for 30 years after retirement rather than 22 will have waved goodbye to £120,000.

Transferring your pension away from your employer

A final salary company pension normally provides: annual increases in line with inflation; a spouse’s pension; and the option to take tax-free cash. All are calculated according to the rules of the scheme and average life expectancies. Someone heading for a £20,000 pension with cost of living increases at 65 might typically be offered a cash lump sum of £92,308 and a lower annual pension of £13,846, according to Hymans Robertson.

However, if you do not need a spouse’s pension and have lower than average life expectancy, you might consider a transfer because superior terms may be available with a private insurer.

By transferring out, you would also be free to give up your annual increases and spouse’s survivor pension for
a higher initial pension.

Furthermore, different factors would be used to calculate the tax-free sum, so this could be larger. If you qualify, you could also use flexible drawdown to get even more money from the fund.

While these features may be attractive to some retirees, they could prove highly costly over the long term for the majority of pensioners.

The transfer value will not be sufficient to replicate the guarantees provided by an employer’s scheme.

Only by giving up various benefits can retirees secure higher initial pensions. For example, the transfer value of a £20,000 annual escalating pension would typically be £460,000, according to Hymans Robertson.

In an insurance company pension or Sipp, you could take 25%, or £115,000, as tax-free cash, giving you one-quarter more immediate cash than if you had stayed with the final salary scheme.

The remaining transfer value of £345,000 could then be used to buy a pension. If you wanted to maintain some cost of living protection, you would now get only £11,000 — more than £2,000 less a year than if you had stayed with your employer’s scheme.

However, this rises to £14,000 with poor life expectancy, so someone with health issues might be better off by switching out.

Similarly, if you buy a level pension, with no cost of living rises, you might get £17,000. If you are in poor health and give up a spouse’s pension as well, that rises again to £22,000.

Russell-Smith said: “So you can take 25% more tax-free cash and buy a flat pension 25% higher on day one. If your life expectancy is poor and you don’t want a spouse’s pension either, you can get 60% more.”

But there could be a high price to pay. Khalaf said: “We already see situations where women are widowed and only at that point do they discover that they have been left with nothing to live on.”

Sum alert

Deciding whether to take a tax-free lump sum at retirement will depend on your health, tax status and finances. However, figures from Hymans Robertson show that those in final salary schemes typically end up receiving only 50% to 60% of the value of the sum they surrender.