Final Salary pension transfer guide

If you hold a private sector Final Salary pension, you have the right to request a transfer, as do members of so-called ‘funded’ public sector schemes. Some public sector schemes, such as those for teachers, NHS workers, the armed forces, the civil service, police, and fire service are known as unfunded and can’t be transferred.

For most people, taking a pension from their Final Salary pension will be a better option than transferring to a different type of scheme. However, for some people, the benefits offered by a Personal Pension will meet their needs more closely.

Why would I transfer my final salary pension?

As part of the April 2015 pension rule changes, 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. But why?

Greater flexibility - If you have a defined contribution pension, you can withdraw as little or as much as you like from the age of 55 (this will rise to age 57 from 6 April 2028) allowing you to manage your savings more flexibly through income drawdown rather than having to buy an annuity.  

Inheritance tax benefits -  the new rules removed 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. 

Death benefits – a defined contribution pension allows you to leave remaining pension funds to your children after you and your spouse have died The perceived benefits of transferring a Final Salary pension have to be considered in tandem with weighing up the loss of a guaranteed inflation linked income.

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. 

Stages of a Final Salary Pension Transfer

The first stage - You or your adviser request a 'statement of entitlement' from your pension scheme, your pension scheme should notify you that you need to take professional financial advice 

After 1-3 months - Your pension scheme confirms the 'transfer value' of your pensions along with other information about the scheme. You fully discuss this information with your adviser and ensure you consider all advantages and disadvantages bearing in mind your specific circumstances. The transfer value will be guaranteed for 3 months from the date it was calculated. This is your deadline to confirm that you want to transfer your pension and provide proof that you've taken financial advice. You can request a new transfer value if the deadline has expired, typically, you are allowed one free transfer value in any 12 month period.

After 3-6 months – If you proceed with a transfer, it typically takes 1-3 months from receiving your application for the new pension to receive the transferred funds 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.  Financial advisers descended upon Port Talbot, where most of the Tata workers were based, some workers 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 should have stayed within the existing scheme.

Since then, 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 will be required to hold a specific qualification for providing advice on investments by October 2020.

Before you seriously consider leaving a Final Salary pension, you should have a good understanding of the risks of swapping safeguarded benefits for flexible ones. A guaranteed income for life I a significant benefit to give up. 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.

Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people

The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.

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