Pension Income Choices: Defined Benefit Schemes
The last article covered the pension income choices offered by defined contribution, (also know as money purchase schemes), which embraces all of the choices offered by Pension Freedoms for April this year.
For a defined benefit, (or final salary), scheme there is a clear and almost brutal dichotomy – which can be summed up as “take it or move it”
For the vast majority of members of final salary schemes, their best option will be to take the scheme as it stands. Often there is a choice over how much tax free cash to take compared to annual income, but in the scheme of things, this choice is almost trivial.
Almost all final salary schemes offer inflation proofing on income, (although it may be capped at 5%), so taking an excessive amount of tax-free cash is not in the member’s best interests. As a planning point, take as little tax free cash as possible, say just enough to clear expensive debt, to maximise the index-linked income. If you have a large quantity of expensive debt, like credit cards at 26%APR, then more tax-free cash would be sensible, but please remember that this is a variation of Peter robbing Paul; what you spend clearing down debt is not available as long term income.
Most final salary schemes offer 50% spouse’s pensions with indexation, so the value of the pension is harder to judge than a money purchase scheme. The value of the scheme will only be extinguished when both partners have died, so be very wary of rapid comparisons offering transfers of pension benefits to improve “death benefits”.
There are a very limited number of circumstances where moving a defined benefit scheme to the money purchase arena is likely to be for the benefit of the member. At the very least, there will be a significant transfer of investment risk from the pension scheme to the pension member, which will reduce their security overall and potentially reduce the available income considerably.
There are also substantial costs in pension transfers, so all transfer suggestions should be treated with caution, but if any of the following circumstances apply, it may be worth considering:-
- Serious ill health, with a life expectancy of 12 months or less
- No spouse
- General ill health, with a life expectancy of less than the norm.
- A need to access large sums of capital to facilitate a divorce, avoid personal bankruptcy or imprisonment for fraud or similar
- A lack of trust with the pension administration, the trustees or the sponsoring employer.
Any transfer will need professional financial advice, as most pension trustees, annuity and draw-down providers will ask for proof of advice.
Serious ill health; under HMRC rules, if you can demonstrate a life expectancy of 12 months or less at any age, you are entitled to your pension money tax free, so long as you are under 75, when some tax will be payable. This may not be possible in the original pension scheme, so a transfer may be necessary. A recent article in the Saturday Telegraph gives an example, http://www.telegraph.co.uk/finance/personalfinance/pensions/11921392/This-pension-loophole-saved-me-176000.html
No spouse/General ill health; this is where your circumstances mean that you are unable to benefit from the usual provisions of the pension scheme. Here, the decision to transfer or not will depend very much on the likely cost of an alternative annuity contract.
A need for capital; releasing capital comes at a high price, so the need must be great and demonstrable to a sceptical adviser.
A lack of trust; possibly the hardest to argue, especially as an underfunded scheme will restrict any transfers to the funded amount. If the likely pension is above the Pension Protection Funds limits, then a transfer may be advisable, but the cost will be high.
The end game
Once a final salary scheme has been transferred out of the existing scheme, the options of a money purchase scheme become available for the balance, after any specific needs and transfer costs.
Many people, and I include myself, will find themselves with a number of pensions with different basis, terms and normal retirement ages. This portfolio of pension provision will require each pension scheme and fund to be treated individually to make the best of resources. I intend that the defined benefit schemes will provide the certainty in my pension income, with investment risk being taken with my money purchase resources. This approach lends itself to a phased retirement and regular professional advice.
Contact me with queries
If anyone is looking for general advice, then please write in to the blog and I would be happy to help with anonymous advice posted here. Alternatively, please call us on 0116 253 5600 and ask to speak to an IFA, (Independent Financial Adviser), for a no-obligation discussion.
If you know you need formal advice, have a look at http://bankfield.net/personal/retirement-planning/, or ask around for a recommendation, it might even be me.