This information will help you understand the value of a defined benefit pension if you are considering transferring out of a defined benefit pension scheme.
If you transfer out of a defined benefit pension, you cannot reverse it. Make sure you understand the risks to help you make an informed decision.
Defined benefit pensions
A defined benefit (DB) pension, sometimes called a final salary pension, gives you a guaranteed lifetime income that usually increases each year to protect you against inflation. It may also continue being paid to your partner at a reduced rate when you die.
When you start taking your pension, you can usually choose to receive a tax-free lump sum in return for giving up some of the income. You don’t have to make any other decisions because the employer and trustees of the scheme are responsible for making sure there is enough money to make your payments. You pay no charges as a member of a DB scheme.
Defined contribution pensions
In a defined contribution (DC) pension, you invest funds to build up a personal pot of money and pay charges to the pension scheme operator and investment managers. You can choose how to use your pot to give you allowable tax-free lump sums and your retirement income.
The value of your pension pot is affected by changes in the value of the assets you invest in - such as shares, bonds and property - and it will go up and down in value. There are no guarantees that your pension pot will let you maintain your chosen level of income for the rest of your life, unless you chose to buy a guaranteed lifetime income, known as an annuity. You can say who you want to receive your remaining pension pot when you die. You or your adviser are responsible for managing the pot until it runs out. You need to pay charges to an adviser if you choose to take advice on how to invest.
If you are considering transferring your DC pension, see our webpage for more information.
Risks of transferring
The FCA and The Pensions Regulator (TPR) believe that it will be in most people’s best interests to keep their DB pension.
If you transfer from a DB scheme to a DC scheme, you:
- lose the guaranteed lifetime income from your DB scheme, for you and your dependants
- lose the inflationary protections offered by your DB scheme
- have to pay a DC scheme, and investment managers, to manage your pension and the investments in it, which will reduce the value of your pension pot
- have to decide how to invest your money, or pay someone to do it for you
- may see your pension pot fall in value, as well as rise
- may have less income in retirement, particularly if the value of your pension pot falls
- may run out of money in your lifetime
Who is least suited to a transfer?
A transfer is probably not for you if:
- this is your main or only pension
- you will rely on income from this pension throughout your retirement
- your DB pension meets your needs, so you don’t need to take investment risk
- you have dependants who might prefer some of the DB pension features, such as a guaranteed income rather than a lump sum
You may be less suited to a transfer if you cannot accept a lower income. For example, you may be considering a transfer because some of the features of a DC pension scheme appeal to you, such as flexibility or control of your money. But using these features often means having to compromise in other areas, such as the level of income you can take. This means you might struggle to achieve the retirement you want, for example:
- if you want a higher tax-free lump sum you will have to take a lower income from your pension
- if you want to retire early, your money will have to last for longer so you will need to budget for a lower income over time
- if you want control of your money you will need to manage your investments and pay charges which will reduce the amount in your pension pot
You may be less suited to a transfer if there are alternative options available, for example:
If you want your family to inherit your pot on your death, you need to remember that by the time you die, you may have spent a lot of the money. Most people near retirement today will live well into their 80s, with many surviving into their 90s. If you want to protect your family financially, you could consider buying life insurance instead.
If you think the employer who runs your DB scheme might become insolvent, you should check the protection available from the Pension Protection Fund (PPF) for eligible schemes. Visit the PPF website for more information.
Who is best suited to a transfer?
Most DB scheme members who would benefit from a transfer do not rely only on their DB scheme to meet their income needs and will usually have other sources of retirement income. For example, they may have other pensions and investments. Alternatively, they may be managing income for wealth or tax planning by taking it sooner or later, in a way that does not impact on their ability to meet expenditure needs throughout retirement.
If you have a limited life expectancy, you want your family to be financially secure on your death. If you transfer, you may be able to get more value from a transfer for yourself and your family than if you stay in a DB scheme. But you should also consider whether you and your dependants would be better off with the guaranteed income from a DB scheme. If you die within 2 years of a transfer, there could be extra tax charges to pay.
There may be rare occasions when those in serious financial difficulty could benefit from a transfer. But this will generally mean sacrificing long term security for short term gain.