BLOG: Defined benefit pension transfers – friend or foe?
Defined Benefit transfers in the 1980s were commonplace. For various reasons, not all were based on sound advice, but of course, many were based on the guidelines at that time.
The advice in those days may well have been appropriate, but it still likely resulted in many people being financially worse off – some, considerably so. It was, of course, more common for there to have been commission-based sales people in those days who could have been tempted to recommend an inappropriate transfer, as this was the only way that they would get paid.
Unfortunately, though, hindsight teaches us a lot and it can sometimes be easy to judge something that is only possible with the benefit of hindsight. DB transfers are now rare, critical yields are generally unachievable even by the most optimistic, and the risk of moving from a ‘secure’ environment to a personal risk environment is unacceptable for many DB pension scheme members.
Fortunately, times are once again changing. For many, financial advice has evolved into financial planning, the result being that advice is completely personalised to you, the client, and your specific circumstances.
In the case of a DB transfer this means that while a critical yield may be high, it may still be appropriate to transfer. An obvious example here would be a single person approaching retirement with no need to provide the spouse’s pension that is automatically priced into a DB scheme. For this individual, even an annuity may be better value as it could be purchased on a single life basis if he or she is confident that a spouse’s pension will not ever be required.
Or, it could be that the death benefits are important, so there is the potential to leave a residual fund value to an adult son or daughter which would not be possible with a DB scheme. In this case, it is possible that a transfer to a pension such as an unsecured pension arrangement (previously called, and still more commonly known as, Income Drawdown), may be suitable. This would mean that the fund remaining after the member’s death could be left to provide either a lump sum or income benefit to someone other than a spouse or financial dependent.
Financial planning has enabled decisions to be based on more than the obvious single person situation or where no spouse’s pension is required. Typically, a wealthy individual would still retain a DB scheme. This is because it will provide the foundation for solid, guaranteed income on which other investment decisions can be made.
However, for the wealthy, inheritance is likely to become an overriding factor. This is because if pension funds are retained, they can be passed through the generations either within pension wrappers or outside; the pension holder then uses other wealth to reduce the value of the overall taxable estate. Cash flow modelling allows us to look at scenarios with many different assumptions so that we discuss all aspects of risk along with the overriding goals and objectives. It is quite likely that the overall estate may be worth more, without impacting the member’s standard of retirement, and thus enable greater wealth to be passed on to future generations.
Rebecca Taylor is managing director of Aurea Financial Planning