MOST salaried employees consider a final salary or defined benefit (DB) pension a more straightforward and secure option than managing a pot of their own investments via a defined contribution (DC) scheme.
However, those who’ve heard reports that it’s possible to transfer final salary benefits into a pot of money worth up to 40 (yes, 40!) times the annual benefit the scheme provided may be changing their minds.
Is taking the guaranteed income option the best thing for you, or are you missing out on a much better proposition? The answer is as simple as it is complex: It is appropriate for some people, sometimes.
For those with straightforward affairs and a need for a steady income to replace their earnings and supplement the state pension, the best course of action is to usually stick with the scheme.
However, no one’s affairs are entirely straightforward. The following factors are just a few of the many that should be considered before a transfer should take place:
Death benefits of the scheme
Single people generally can’t pass their final salary pension on to their children or grandchildren upon death. A DC pot can be passed on to any named beneficiary.
It also escapes inheritance tax and can often be withdrawn by the beneficiaries tax-free.
Those with a final salary pension who are not in need of the income it provides, may wish to convert it to a DC pot as a potentially tax-free inheritance for their families.
This will not be subject to 40% inheritance tax like most other assets, such as property.
Those with other sources of income contemplating taking final salary pension benefits should be aware that they may be subject to income tax at the highest rates.
They may also fall into the individual’s estate upon death, and therefore be liable for inheritance tax. The assets passed on in this scenario may consequently end up being taxed multiple times at 40%, compared to being completely tax-free in a DC scheme.
The security of the company paying your pension
Final salary schemes are typically insured by the Pension Protection Fund (PPF), but there are limits to the insured amount. Well managed, diversified pension portfolios could, in fact, bear less risk than a single employer-funded scheme if your income in retirement exceeds those limits.
The options for a tax -free lump sum
Schemes can vary in the amount of lump sum they offer, and some offer none. DC pensions offer a tax-free lump sum of 25% up front, and the rest can be ‘rolled up’ in the pension environment and left until a future date for tax-savvy withdrawals, using all available allowances.
For most people, deciding what to do with their pension is likely to be the biggest investment decision of their life. It is therefore vitally important to fully explore all the options available and seek expert advice before simply cashing in.