In our weekly series, readers can email in with any questions about retirement and pension savings to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he does not know about pensions. If you have a question for him, email us at money@theipaper.com.
Question: I will start receiving £20,000 a year from the age of 55 from a final salary – or defined benefit (DB) – pension that I have. How can I find out a cash equivalent value of my DB pension pot and what do I need to consider before transferring it into a pot I can draw from flexibly instead?
Answer: There’s a fair bit of pension jargon in your question, so let’s unpack that before looking at the things you need to consider. A DB pension pays a promised income for life based on the number of years you were in the scheme and your earnings – usually either the average over the course of your employment (often referred to as a ‘career average’ scheme) or your final salary before reaching normal pension age (the age at which your pension income becomes due).
Age 55 is very young to become entitled to a DB pension, so I’d double check to make sure this is correct before doing anything else.
In a DB scheme, your employer takes on responsibility for paying your retirement income, with that income usually rising each year by at least the level of inflation. There will also usually be a reduction in the starting pension amount if it’s paid earlier than the scheme’s normal retirement age.
A defined contribution (DC) pension, by contrast, is a pot of money you build up and invest over your career, with contributions boosted by upfront tax relief and investment growth also completely tax free.
If you are employed, you may also benefit from employer contributions. You can usually access your DC pension from age 55 (rising to age 57 in 2028).
Where a DB pension is inflexible and guaranteed by your employer, a DC pension can be accessed as and when it suits you. However, this requires you to take responsibility of how and when you take an income and, crucially, ensuring that your fund lasts throughout your retirement.
If you have a “funded” DB pension – which just means a DB pension where the scheme invests in assets to pay your promised pension – you should have the option of requesting a “cash equivalent transfer value” (CETV) from your scheme.
This is your scheme’s actuary’s estimate of the value of your promised pension as a cash amount if you chose to transfer to a DC alternative. However, if you DB pension is “unfunded” – which is the case for most public sector DB schemes, except for those administered by local government – you will not be able to transfer your pension.
Assuming your DB pension scheme is “funded”, you should be able to ask your administrator for a CETV. It’s important to note that if you want to transfer to a DC arrangement, you will usually need to complete this before you start receiving an income payment from your DB scheme.
As your DB income will be valued at well in excess of £30,000, you will also be required to take regulated financial advice before transferring. This requirement was introduced in April 2015, with the aim of helping those who might want to transfer and take advantage of the extra flexibility available in DC pensions to make an informed decision.
Giving up a guaranteed DB pension is a massive financial decision and one that should not be taken lightly. DB pensions have pretty much disappeared from the private sector in part because they are so valuable to employees and expensive for employers.
You will also need to be prepared to take an active role managing your DC pension, choosing where to invest your money and how and when to access your pot. You will also need to review your strategy regularly to make sure you are still on track.
Another significant consideration could be inheritance tax (IHT). From 6 April 2027, unspent DC pensions will count towards your estate for IHT purposes, although funds passing to a spouse or civil partner will remain exempt.
In contrast, a dependent’s pension entitlement linked to your DB pension (these types of pension often pay 50 per cent of your promised income to your spouse when you die) will remain free from IHT. The difference may therefore be more relevant where benefits are left to children or other non-exempt beneficiaries.
If you pursue a transfer and the regulated advice recommends against the transfer, you should take that advice very seriously, as they have your best interests at heart.
And while you can still technically transfer a DB pension after such a recommendation, many providers will not accept the funds without a positive recommendation.
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