Should you cash-in your final salary pension?
By Patrick Goddard, Independent Financial Adviser
If you have a final salary pension scheme, many people may be rather envious! These schemes, which usually pay a proportion of your salary at the time you retire, are now few and far between.
Final salary schemes are a type of pension known as ‘defined benefit’ – no matter how the markets perform, you know how much you’re going to get when you retire.
But most schemes now are ‘defined contribution’ schemes – the only certainty is how much gets paid into the scheme, not what your payout may be.
The certainty of a final salary scheme is what’s so appealing. So who would give that up?
Well, with the pension reforms which come into effect in April 2015, everyone has considerably more freedom in how to use their pension fund – whether it’s a defined benefit or defined contribution scheme.
No longer is it compulsory to buy an annuity. Individuals can choose to take the cash and use it as they wish.
For many this means that making investments and living off the income (called ‘income drawdown’) could actually produce a greater return for them, potentially even greater than their final salary scheme.
Of course, investments are uncertain, although there are options with different degrees of risk and anticipated return.
The other freedom is that the entire residual cash value of this kind of pension arrangement can be left to your family when you die – for example, a spouse, a partner, child or grandchild. Final salary schemes typically don’t offer that kind of flexibility.
But giving up a final salary scheme is a decision which must be taken carefully. Firstly, you need to be clear what the ‘transfer value’ of your pension fund is – how much cash you would get if you gave it up. Contrast this with how much you would receive every year for the rest of your life if you kept the final salary pension… and don’t be tempted to give up that security for too cheap a price.
But, if you have accumulated a generous pension fund, then do think seriously about whether your present arrangements best suit your circumstances. This is where a financial adviser can help you (and indeed, the government is making it compulsory for you to take advice first, so you make a well-informed decision).
If you’re considering how best to fund your retirement, then do get in touch with us. It’s an important decision, made even more complex now by the regulatory changes which present so many more options. We can work through the financial projections for you, to make sure you can plan your future with confidence.
Case study: Mr & Mrs J
At age 63 Mr J has decided he would like to retire early. His wife was able to retire a couple of years ago and has an excellent teacher’s pension. He has his state pension and a final salary pension available to him at age 65.
The final salary scheme is projected to pay £8,000 pa on an index-linked basis but cannot be taken before age 65, and if he were to die before then the death benefit would be a return of contribution of £24,000. After taking benefits his wife would receive an income of £4,000 pa on his death.
He will need around £12,000 pa to see him through the next two years. A cash equivalent transfer value of £270,000 has been obtained from the scheme trustees. Mr J decides to transfer his benefits to a flexible personal pension arrangement which will allow him to access the £1000 per month income he requires from April 2015. He takes part of this as tax-free cash and part as taxable income but will not have a tax liability after use of his personal allowance. He also knows that on death this arrangement would pay the whole remaining fund value to his wife tax free, and he feels he has helped future generations as a consequence.
When he receives his state pension he intends to reduce the amount he takes from his personal pension. The funds in his new arrangement will continue to be invested with the potential for growth but they could also reduce in value with the risk of them running out. For this reason Mr J may opt for a pension product at age 65 that gives a guaranteed minimum income regardless of investment performance.
Making the switch needed very careful consideration as it would require giving up a guaranteed, index-linked income. However, after weighing up the options Mr J felt the change offered some compelling benefits that the new pension freedom rules have made possible.