What are the benefits of final salary pensions?
Defined benefit and final salary pensions are often seen as 'golden' pension deals.
This is because final salary or career average pensions give you a guaranteed income when you come to retire, which often rises with inflation each year and pays attractive death benefits (such as a pension to your surviving spouse).
This kind of deal is really expensive to replicate if you have a defined contribution pension, which sees you save into a 'pot' which is invested and then you decide how to take an income from it.
To get a guaranteed, inflation-linked income with a defined contribution pension, you would need to buy an annuity.
Using the Money Advice Service's annuity calculator, a pension pot worth £500,000 would only buy you an annual income of just over £15,000 a year.
That's why it is usually best to leave your money in a final salary pension rather than transfer it to a defined contribution scheme.
Why transfer my final salary pension?
Greater flexibility and access to cash
As part of the April 2015 pension freedoms, you may be permitted to transfer from a private defined benefit scheme to a defined contribution pension (after taking regulated financial advice).
This has transformed the retirement plans of thousands of people and produced a sharp rise in savers transferring their defined benefit pensions to defined contribution schemes.
If you have a defined contribution pension, you can withdraw as little or as much as you like from the age of 55; managing your savings more flexibly through income drawdown– rather than having to buy an annuity.
Inheritance tax benefits
Another change is the removal of the 55% tax on your remaining pension pot after you die.
Under the current rules, if you die under the age of 75, your funds can be inherited tax free. If you die aged over 75, it can be passed on as a lump sum subject to income tax at your heirs' personal rate.
What are people doing?
These changes make the prospect of quitting a generous final salary pension, and transferring the cash you could get to a defined contribution scheme, more attractive.
When we surveyed Which? members in January 2020, a third of those with a final salary scheme not yet in payment said they would consider a transfer.
Being able to take advantage of greater flexibility was the most popular reason (44%) given by those who said they’d contemplate transferring.
Other reasons given by possible transferees included having other retirement provision (38%), being able to access their money sooner (23%), passing on an inheritance to beneficiaries (21%), taking advantage of generous transfer values (19%) and fears about the scheme going bust (17%).
How much will I get if I transfer my final salary pension?
If you do decide to transfer your final salary pension, the amount you get to invest is known as the 'cash equivalent transfer value', which is calculated by your final salary scheme.
You must then invest this 'amount' in either a pension scheme with another employer or a personal, self-invested or stakeholder pension.
The cash-equivalent transfer value is basically the amount of money your pension scheme would need today to make sure it could cover the cost of the benefits you were guaranteed to receive in the future, were you not to cash them in.
Traditionally, transfer values have been calculated as a multiple of around 20 times the annual income due at retirement.
For example, a final salary pension worth £10,000 a year would produce a lump sum of £200,000. More recently, transfer values of 30-40 times the final salary benefits have been offered.
High transfer values have been driven by two main factors – companies’ desire to reduce their schemes’ liabilities and the current low-interest-rate environment.
The two are linked. Low interest rates over the past decade have meant low gilt yields, and as pension schemes are funded by investments in gilts, companies are finding it harder to afford promised pension benefits.
They have offered higher or ‘enhanced’ transfer values, as a result, to rid themselves of future pension liabilities.
Gilts and your final salary pension
Many schemes invest in UK government bonds, or ‘gilts’. These are essentially loans to the British government in exchange for a fixed rate of interest, with the loan repaid at a future date.
Gilts are seen as low risk, as the UK government is unlikely to go bust and therefore not repay its debts, which is useful for pension schemes because they pay incomes for decades and need secure investments.
However, returns on gilts have fallen in recent years. So, if the scheme assumes that growth on its investment is going to be lower, it would need a larger lump sum today to cover the cost of your future pension benefits – meaning a larger cash equivalent transfer value for you.
If it had a different investment strategy – say it invested more in shares – and it predicted the money would enjoy better returns, it may pay you a smaller lump sum.
It’s tough to know what makes a good or a bad deal, as different companies use different assumptions for the returns on their investments.
Final salary pension transfers: FAQ
We answer your key questions about final salary pension transfers.
Who can transfer their workplace final salary pension?
If you hold a private sector final salary pension, you have the right to request a transfer, as do members of 'funded' public sector schemes.
A funded scheme is one that sets aside a pot to pay out pension incomes to employees.
Some public sector schemes, such as those for teachers or NHS workers, aren’t linked to specific pension funds (they’re paid out of general taxation) so members of these can’t transfer out.
If you’ve already started drawing on your pension, you won’t be allowed to cash out, and if you do decide to make the switch, you’ll be leaving the scheme for good.
When might you transfer your workplace final salary pension?
In some circumstances, perhaps if you aren’t reliant on the final salary income only, a transfer could make sense.
A transfer would give you the chance to pass on some of the cash as an inheritance. That can’t usually be done with a final salary scheme.
Cashing in might appeal if you only receive a trivial amount each month and a lump sum would prove more useful.
For example, a £60 per month pension could translate into a cash-in value of around £25,000, based on 35 times the annual income. The figure with differ depending on your pension scheme
When shouldn’t you transfer your workplace final salary pension?
You might decide to transfer yourself or be persuaded by an adviser to do so. Stories about pension schemes being in deficit – ie the fund owes more money to members than it will be able to pay out – might prompt you to transfer your cash.
The reality is that people are protected by the Pension Protection Fund (PPF), a government-run fund to protect people in DB pensions that go bust.
If you’re already retired you’ll get 100% of your pension if you were past normal retirement age.
If you are yet to retire, you are likely to get 90% of your pension once you reach normal retirement age. Pay-outs are capped.
Do I have to take financial advice to transfer my pension?
Anyone making a transfer worth more than £30,000 must seek financial advice. There are many advisers with specialist qualifications to assist on transfers, but there are also cases of poor advice on pension transfers identified by the FCA.
Some advisers will charge on a ‘no-switch, no-fee’ basis, which will mean a large fee if you cash out, and nothing if you don’t. This could cloud their decision on what is best for you.
A reputable adviser should:
- Consider what you need (or want) from your pension, based on your financial circumstances and goals.
- Consider how well your existing pension will provide for this.
- Consider which alternative arrangements are suitable for you – and if the benefits are enough to outweigh the cost of switching.
- Explain the potential risks and benefits of switching or staying put.
- Explain clearly what the advice will cost you and, if you switch, the fees you’ll need to pay.
Find out more in our guide to how to get retirement and pension advice.
What should I do with the money from my final salary pension?
If you do decide to cash out, you’ll need to plan what you’ll do with the proceeds. A reputable adviser won’t sign off a transfer without providing alternative recommendations.
The most common arrangement is income drawdown, allowing you to leave your pension pot invested in the market.
By staying invested, you may benefit from capital growth and income from your investments – but there’s a chance you’ll either run out of money.
Alternatively, you could buy an annuity, but it is unlikely you will be better off cashing in a final-salary scheme to do this. Annuity rates are very low for the same reasons transfer values are high.
You may also think about cashing in your pension to invest in another way entirely, such as buy-to-let property.
But be careful – you can only access 25% of your pension tax-free; you need to pay income tax on the rest.
How long could a final salary pension transfer take?
Our step-by-step guide takes you through the stages of transferring your pension.
The first stage
You request a 'statement of entitlement' from your pension scheme
After one month
Your pension scheme should notify you that you need to take professional financial advice
After three months
Your pension scheme confirms the 'transfer value' of your pensions and will send the paperwork with a deadline to take financial advice
After six months
This is your deadline to confirm that you want to transfer your pension and provide proof that you've taken financial advice
After nine months
This is the deadline for your pension scheme trustee to complete the transfer.
What have been the problems with pension transfer advice?
Sadly, there have been many cautionary tales that highlight the dangers of exiting your final salary scheme.
Workers at Tata Steel (formerly British Steel) were faced with a decision about what to do with their final salary pensions at the end of 2017 – switch to a new scheme, or take a lump sum.
Unscrupulous advisers descended upon Port Talbot, where most of the Tata workers were based, and persuaded them to cash out and put their money into unsuitable high-risk and high-cost investment funds.
For many steelworkers, their final salary pension was their only source of retirement income and they’ve been left bereft after having to make a very complex choice. The National Audit Office is investigating the FCA's handling of this scandal in 2022.
Since 2018, the Financial Conduct Authority (FCA) has been working to improve the quality of pension transfer advice.
The regulator’s view is that advisers should start from the assumption that a transfer will be unsuitable for most people. Under new rules, all pension transfer specialists are required to hold a specific qualification for providing advice on investments.
The regulator stopped short of a ban on ‘contingent charging’ – where a fee for advice is only paid when a switch goes ahead.
To make you think twice about transferring, the FCA also now requires advisers to provide you with what’s known as ‘the transfer value comparator’ (TVC).
Read our guide to how to find a financial adviser to find a reputable one, and think very carefully before you transfer.
Should you consider a final salary pension transfer?
Opting to cash in a DB scheme is not a decision to be taken lightly. It is for good reason that the regulator has taken a keen interest and warned advisers to take a very cautious approach when talking to potential transferees.
Its tightened rules have seen a number of advisers exiting the market, and latest figures show that pension transfer activity is starting to slow – yet many savers will continue to be tempted by the eye-watering lump sums on offer.
There are certain circumstances in which transferring can make sense, but getting professional pension advice is essential. You need to have a clear understanding of the risks of swapping safeguarded benefits for flexible ones.
A guaranteed income for life remains the gold standard for pensions. Forgoing this opens up the possibility that you’ll have less to live on than expected – and you could even run out of money altogether.