If you have a ‘defined benefit’ or ‘final salary’ UK pension that you have not accessed yet, you could find your pension is worth much more than you think. This is because current ‘transfer values’ – pay-outs offered for cashing in these pensions – are at historically high levels.
In final salary pensions, your employer commits to pay a proportion of your salary – usually increasing annually with inflation – for the duration of retirement. Offering the security of a minimum income for the rest of your life, these pensions are considered extremely valuable. Transferring out of such a ‘gold-plated’ arrangement is not generally seen as sensible.
However, with some transfer values increasing by hundreds of thousands of pounds, the tide may have turned. Usually, transfer values are calculated as a multiple of 20 times the annual salary due at retirement, but today there have been cases of transfer values at 40 times that amount. In simple terms, for a £30,000 final salary pension, this means a £600,000 pay-out would have increased to £1.2 million! Clearly, such a high sum could potentially provide a regular retirement income in excess of the original annual benefits.
Why are transfer values so high?
Essentially, many companies providing final salary schemes are finding it harder to afford promised pension benefits. Higher-than-usual transfer values are one way of reducing future liabilities.
Schemes are generally funded by investments in government bonds, which are consistently underperforming amid low interest rates. Add to this the trend for people to live decades into retirement – meaning a longer commitment to provide benefits – and there is often a shortfall. One estimate puts the total deficit of UK private sector pensions at over £780 billion, with one in five FTSE pension schemes considered high risk.
The recent collapse of several high-profile pension schemes highlights the problem. Members of the failed BHS and Carillion schemes, for example, are now set to rely on the government’s Pension Protection Fund (PPF) to fill the gap. This compensates 90% of pension benefits due up to £34,655 a year (at age 65), so if your pension benefits exceed this, consider your options. Once a scheme is under assessment by the PPF, you lose the opportunity to transfer.
Will the trend continue?
With UK interest rates predicted to rise in coming months, the deficits of final salary pension funds may narrow as returns on bonds improve. If pension provision becomes more affordable, transfer values will decrease. However, this will not happen overnight – particularly with the Bank of England’s promise of “gradual and limited” rate increases – and Brexit uncertainty is likely to maintain risk for pension scheme investments. Nevertheless, this could mean a limited window of opportunity for today’s historically high transfer values.
The pros and cons of transferring
Other than a generous one-off pay-out, transferring from a final salary pension can provide more flexibility. With estate planning, for example, you could potentially pass on pension benefits to any heirs; final salary pensions are usually only available to your spouse on death.
You could also gain more control over where your money is invested and how and when you can make withdrawals. For expatriates, more choice about whether to take pension income in Euros or Sterling can be particularly convenient and minimise currency exchange risk. You could also take advantage of opportunities to reinvest in more tax-efficient structures for Portugal.
The flipside of this is that transferred funds have the potential to run out within your lifetime. As many people can expect to spend 30 years or more in retirement, you need to make sure you have a strategy in place to see you through for as long as you need. Once transferred, pension benefits also become exposed to investment risk that is absent with a guaranteed income. The worst-case scenario is you could lose everything to pension scams or to unregulated investments that provide no compensation if things go wrong.
Ultimately, whether you should transfer a final salary pension depends on numerous factors, including the value of your other assets and your unique set of circumstances and goals. Remember: transferring means forfeiting the right to a guaranteed lifetime income for a one-off payment – and is irreversible – so take extreme care to ensure you are making the right decision.
Today’s generous transfer values may be short-lived, so if you do decide to act, move quickly. Make sure you take personalised advice from a pensions’ professional regulated by the UK Financial Conduct Authority. While this is compulsory for benefits worth £30,000+, it is advisable for everyone to fully understand the long-term implications and do what is best for you and your family.
Blevins Franks accepts no liability for any loss resulting from any action or inaction or omission as a result of reading this article, which is general in nature and not specific to your circumstances. Individuals are advised to seek personalised advice.
By Adrian Hook
|| features@algarveresident.com
Adrian Hook is a Partner of Blevins Franks and has been providing holistic financial planning advice to UK nationals in the Algarve since 2007. Adrian is professionally qualified, holding the Diploma for Financial Advisers.
www.blevinsfranks.com
