The final salary pension decision: what should you do?

Gold-plated. Gold standard. Or how about the less glitzy ‘copper-bottomed’ or ‘cast-iron guarantee’? However you look at it, final salary (or defined benefit) pensions have a formidable reputation as the pinnacle of retirement savings and the most attractive option available.

As the name implies, a final salary pension (if you have one) is provided by your employer.

You save into it during your working life and in return, you receive a guaranteed income each year after a pre-agreed date (usually your retirement date). The amount usually rises annually to keep pace with inflation.

Yet final salary schemes are becoming scarce. Existing schemes are slamming the door to new members, and only the largest employers and parts of the public sector still offer them. As a result, the number of people with these pensions is dwindling fast.

The decline of final salary schemes

Why are so many final salary schemes closing? In a word: affordability. Pensioners are living longer, while the investment performance of many funds has been underwhelming. So, the cost of providing these has spiralled.

Employers have been worried about the long-term expense of providing final salary pensions, but the final straw was arguably Brexit. After the vote, final salary pension funds were keen to offload their promises to pay pensions for life and were willing to take a bigger short-term hit to stave off longer-term costs.

And so, the cash dangled in front of members as incentives to leave the scheme skyrocketed.

These cash lump sums are ‘cash equivalent transfer values’ (CETVs). To keep things simple, we’ll call them final salary pension transfer values.

These sums are what your pension fund will offer you to transfer out of your final salary pension scheme. By leaving, you forfeit any right to future payments, but you get a pot of pension cash, which may be substantial.

Should I transfer my pension?

That’s a tricky question that will depend entirely on your circumstances, but you must get advice before transferring a final salary pension worth at least £30,000.

You can estimate your transfer value with the Drewberry Final Salary Pension Transfer Value Calculator. Enter some details and you’ll get an estimate of what your transfer value might be.

As well as the above, you can also use Unbiased’s private pension calculator here.

Once you know this figure (and you should check with your pension scheme to confirm the exact sum), you have a lot to think about.

Remember, no matter how tempting the transfer offer might be, you’re giving up a guaranteed income for life. You’ll be solely responsible for investing your pension cash and will be exposed to market volatility – how much you are exposed will depend on your investment choices.

On the other hand, there are many potential benefits to taking the money.

Final salary pension transfer values are unlikely to ever be this high again, as they have been artificially boosted by the eagerness of schemes to offload members.

Moreover, you won’t have to worry about the fund’s continued solvency. Even the government has concerns about the ongoing viability of final salary pension schemes, in light of the financial strain they were under more than a decade ago.

In 2005, the government set up the Pension Protection Fund (PPF) as the pension provider of last resort for those whose final salary schemes end up going under. But the pension the PPF offers if your own fund becomes insolvent before you retire is capped, so it could be a lot less than you were expecting.

The advantages of transferring a final salary pension

One of the biggest benefits for those considering transferring out of their final salary scheme is greater flexibility when accessing your retirement savings.

You have a wide array of options for securing a retirement income. The most traditional is to buy an annuity, which offers a guaranteed income and recently became more appealing as rates have soared.

Another option is income drawdown (often called just drawdown). This is where your pension pot is reinvested in a way designed to generate an income that you can withdraw as and when you need it.

You can also take 25% of your pension pot as a tax-free lump sum. Both of these are possible if you transfer a final salary pension into a personal one, exchanging a guaranteed income for life for a pension pot.

Control income tax and inheritance tax

Another point to note about final salary schemes is that they usually die with you. While some schemes offer a 50% pension to the spouse of the deceased, that will stop on the spouse’s death – so none of the pension passes to the children.

So if you and your spouse die prematurely, that final salary pension may end up being poor value.

But what if you transfer? Assuming you don’t buy an annuity after transferring out of your final salary scheme, you will be in a position to pass on your pension savings to your beneficiaries in the event of your death.

In some instances, your beneficiaries can even inherit your pension pot free of inheritance tax.

You can also have better control over income tax. By entering an arrangement such as drawdown, you can adjust the yearly income you receive to prevent you reaching a higher tax bracket. But if your final salary scheme pushes you into a higher tax band from the outset, there’s not really much you can do.

Advice on pension transfers

If you’re considering transferring out of your final salary pension scheme, you should always seek independent financial advice before proceeding. In any case, if your transfer value is over £30,000 then seeking advice is a regulatory requirement.

Once you’ve consulted your financial adviser, you’ll have the necessary information to hand and the pros and cons laid out for you by an expert. Only then can you make an informed decision about whether a pension transfer is right for you.