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Cashing in your ‘golden’ final salary pension could be a rip-off

FCA finds high number of advisers giving poor advice

Cashing in your ‘golden’ final salary pension could be a rip-off

People looking to cash in their ‘golden’ final salary pension could be getting poor advice from financial advisers, leaving them at the risk of making the wrong decision, a new study has found.

Transferring a generous final salary pension, which pays a guaranteed income in retirement, has surged in popularity since the pension freedoms were introduced in April 2015. According to the Financial Times, an estimated £50bn has been withdrawn from final salary pensions in this way.

If the value of your final salary pension is worth more than £30,000, you have to get financial advice to cash in your deal. But are you at the risk of being ripped off?

FCA warns on ‘unsuitable’ advice

The Financial Conduct Authority – the watchdog that oversees financial advisers – reviewed almost 90 cases of final salary pension transfers carried out by financial advisers since October 2015. It found that in more than half of cases, advisers had either made an ‘unsuitable’ recommendation, or it wasn’t clear if the right advice had been given.

And in 64% of the cases, the regulator found that products advisers had recommended were either unsuitable, or their suitability was unclear.

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What is a final salary pension?

Final salary pensions – also called defined benefit (DB) schemes – are deemed to be the gold standard for retirement saving. They promise a guaranteed, predetermined income for the rest of your life, based on your salary. Unlike defined contribution (DC) pensions, you don’t have to rely on investments to generate retirement income.

The income you receive is based on the number of years you’ve belonged to the scheme, your salary and your scheme’s accrual rate – a formula used to calculate your retirement income as a fraction of your salary, typically 1/60th or 1/80th.

And although the term ‘final salary’ is commonly used, your income may not actually be based on how much you earn at retirement  – it could be an average of your salary during your time at the company.

Most final salary pensions are ‘index-linked’, meaning they increase every year to match rising prices. Your spouse or civil partner will usually receive payments after you die, typically 50% of what you were paid.

Why are people cashing in such generous deals?

The clamour to cash in final salary pensions has been driven by the pension freedoms, introduced in April 2015.  If you have a DC pension, you can now withdraw as little or as much as you like, rather than having to buy an annuity.

Another change is the removal of the 55% tax on your remaining DC pension fund after you die. Under the new 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 or inherited as income, subject to the tax rate paid by your heir.

These changes make the prospect of quitting a generous final salary pension to transfer the cash to a DC scheme far more attractive.

Transfer values on the rise

The value of final salary pensions has been rising rapidly. When you transfer your savings, your pension scheme will pay out the amount it would need to hold today to cover the cost of the benefits you would be guaranteed to receive in future, including your spouse’s entitlements.

To meet this guarantee, the scheme would have invested this pot in the markets. So to estimate your pension’s worth, the fund needs to make assumptions about how the money would have grown over coming years.

Many schemes invest in UK government bonds, or ‘gilts’, as these are seen as low-risk. Gilts are essentially loans to the British government in exchange for a fixed interest rate.

But returns on gilts have fallen in recent years – 15-year yields are currently at 1.34% a year, compared to more than 5% a decade ago. When returns on investments are lower, the pension scheme needs a larger lump sum to cover the cost of your future pension benefits – meaning a larger transfer value for you.

In addition, final salary pensions are expensive for employers to run, which is why hardly any are now offered in the private sector. As a result, the scheme may offer you something called an ‘enhanced’ transfer value, paying a premium to get you off its books.

Do you need advice?

If your final salary pension benefits are valued at less than £30,000, you can take a lump sum directly without having to seek financial advice. Anyone with final salary assets of more than £30,000 is obliged to take professional advice on the transfer, and confirm this to the receiving scheme.

But the FCA says some companies are recommending transfers without making sure their advice is suitable for the person’s circumstances.

As a result, four firms have pulled out from carrying out final salary transfer advice.

If you seek advice, the adviser should specialise in transfers and hold a G60 or AF3 advanced diploma in financial planning, or equivalent.

Should you transfer out of your DB scheme?

While you might want to transfer out of your DB scheme to have more control over your money, you may struggle to generate as much income managing it yourself – either buy buying an annuity or investing it in a income drawdown

But there are times when transferring could make sense – like if you’re in poor health, or have no spouse. If you belong to more than one scheme, or have substantial assets, you may prefer to manage your money more flexibly in a DC pension scheme.

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