Should you cash in your final salary scheme pension?
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. 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.
If you do decide to transfer your final salary pension, the amount you get to invest is known as the cash equivalent transfer value (CETV), 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 CETV value is 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.
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.
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