Defined Benefit – keep or cash in? The big question.
Defined Benefit schemes pledge to pay employees a fixed pension/year based on various factors such as salary and years of service. Paid in to by both employers and employees, the schemes are run by the employer.
There are reports that many large DB pension schemes, at least 1000 according to the Financial Times (13th December 2015), are woefully short of cash so employees are unlikely to receive their promised pension in full. The BHS story is a recent, horrific example. Against this backdrop you might think that cashing in and extracting your cash from your DB Pension would be the best route.
Like many Chartered Financial planners we have seen a steady rise of people obtaining Cash Equivalent Transfer Values (the figure your DB pension is worth if you decide to cash it in) from their pension schemes and then contacting us for advice.
Our advice is not always, in fact is rarely, cut your losses and run. For one, there are definite benefits to having a guaranteed fixed income. But one size does not fit all, so what are the pros and cons of cashing in or keeping a Defined Benefit Pension?
Defined Benefit Pension Schemes (DB) – The Pros & Cons
DB pension key advantages
- Provide a guaranteed, index linked income
- There is no investment risk on the individual. Once you’ve started drawing your pension, assuming you’re past the scheme’s Normal Retirement Date (NRD), even if the scheme goes bust the Pension Protection Fund will continue to pay 100% of your pension. http://www.pensionprotectionfund.org.uk/Pages/Compensation
- The CETV (transfer value) of your DB pension is typically low. One usually has to live 20 years to get the money back when you compare the income from your DB scheme to the CETV you have been given. If you have the misfortune to die early then the 50% spouse’s pension carries on and this will likely mean that you do lose out in monetary terms.
DB pension key disadvantages
- If you want the tax free cash from your DB scheme then you have to take your income[E1] . In contrast transferring to a Personal Pension and going into drawdown enables you to take some tax free cash and leave the rest of the pension invested.
- DB schemes are not very good at providing lump sums of cash in the event of a members’ death, typically they provide a return of the members contributions as a lump sum before retirement, but often no lump sum is paid to the beneficiaries once the member has started taking their pension. Whereas if your money is in a Personal Pension then on your death your spouse/beneficiary receives up to 100% of the fund value.
NB. If you are single/divorced so don’t need to provide for a spouse on death transferring the scheme to a Personal Pension might be more appealing
How to transfer
1. Get a CETV
Approach your DB scheme provider and request a CETV. The first one will be provided free of charge. The scheme will provide a free one every 12 months but will usually charge £250 + vat for another within 12 months. CETV’s are guaranteed for 3 months, after this you need to request a new one.
2. Visit an IFA
Find a recommended local adviser through VouchedFor.co.uk. This is not only good practice, it’s a legal requirement if your DB pension is over £30,000. Look for an adviser who specialises in pensions. The adviser will discuss your options and objectives and talk specifically about future income needs and cashflow (so work out a budget for when you retire).
3. Make your choice
The IFA will prepare a Transfer Value Assessment Report (TVAS) which analyses all the benefits of your DB scheme and compares them against the benefits of a Personal Pension/Drawdown Pension, including looking at the projected income, death benefits, spouses benefits, the inflation linking and the funding position of your current scheme. It’s all very well having an excellent DB pension but will the company still be there to pay it, think BHS?
How long does it all take?
From start to finish at least 3 months, possibly longer depending on how quickly the pension scheme responds to queries.
How much does it cost?
Typically the IFA will charge an engagement fee to prepare the TVAS report and recommendations. Do not be put off by upfront fees from £1,000-£2,000 for preparing such a detailed impartial analysis and be wary if the IFA will do it for free.
What will I get it I transfer?
Once the funds are transferred into your Personal Pension, you can access your Tax Free Lump Sum (up to 25% of your entire pension) and withdraw a taxable income or leave it all invested. The choices are endless! Beware, some providers do not offer all the bells and whistles so speak to you IFA about what you are planning on doing and they will recommend the most appropriate pension provider.