Trying to shut the stable door on Defined Benefit transfers

As more Defined Benefit pension holders choose to transfer out in favour of substantial lump sums, regulators have warned pension schemes they could be offering overly generous amounts, leaving remaining pension holders at risk.

However, with a record £21 billion already being cashed out of Defined Benefit schemes in the year to March, it could be a case of shutting the stable door after the horse has bolted.

A freedom of information (FOI) request by Royal London found The Pensions Regulator (TPR) has written to 14 unnamed Defined Benefit schemes. The letter urges them to reconsider the cash equivalent transfer value (CETV) offers they are making to members given their impact on the scheme’s overall funding position.

The letter states: “In light of recent events concerning your scheme sponsors, we would expect you to take advice from your scheme actuary about whether the basis on which the CETV are calculated remains appropriate. This would allow you to judge whether a reduction or further reduction should be applied to CETVs in light of their assessment of covenant strength.”

Why are retirees choosing to opt out of Defined Benefit schemes?

With Defined Benefit schemes guaranteeing a certain level of income once you retire, such as a Final Salary Pension, they’re often seen as attractive to begin with. In fact, they’re typically described as ‘gold-plated’ and in recent years the number of Defined Benefit schemes has been declining as employers switch to less generous alternatives.

Which leaves the question; why are people choosing to transfer out of the schemes? As life expectancy has risen, it’s becoming increasingly expensive for Defined Benefit schemes to meet their obligations. As a result, schemes have been offering lucrative sums in return for Defined Benefit pension holders cashing out.

It’s not unusual to be offered a lump sum that’s 25 or 30 times higher than the annual pension, and some people have even been offered as much as 40 times. That means if you have an annual pension of £15,000, you can be expected to be offered between £375,000 and £600,000; it’s easy to see why, in some circumstances, this is more attractive than a guaranteed income.

As a result, the findings of Wills Towers Watson research aren’t that surprising. The analysis revealed that the majority of Defined Benefit schemes experience 20-30% of members aged over 55 transferring out of their pension scheme when informed of the option.

However, what’s likely to be more of a concern for current holders of a Defined Benefit pension scheme, is the most recent monthly fund index from JLT Employee Benefits. It estimates that there’s a £3 billion deficit in the Defined Benefits pension scheme funding positions of FTSE 100 companies, and a £40 billion gap across all UK private sector pension schemes.

Sir Steve Webb, Director of Policy at Royal London, commented: “I would hope that well-run pension schemes would be taking expert advice when deciding how much to offer to members wishing to transfer out.

“But the regulator’s letter is a helpful reminder to all schemes that they need to be fair not only to those transferring out but also those left behind, especially where the scheme in question is in deficit.”

Your options with a Defined Benefits scheme

When you have a Defined Benefits scheme, you essentially have two options, both of which have advantages and risks.

Transferring out: When you transfer out of a Defined Benefit scheme you’ll typically be given a significant lump sum. This gives you more freedom when planning your retirement years and, depending on your age when you retire and the figure offered, could mean you end up better off.

However, there are two things to note here. Firstly, following the regulator’s calls, the size of the lump sums offered may begin to decrease. Any changes are highly unlikely to happen quickly, so you shouldn’t rush into a decision. But you shouldn’t always assume that transferring out will mean you end up with more money either.

Another point to recognise is the risks that opting out of your Defined Benefits scheme leaves you open to. For example, you can choose to invest your pension sum, giving you the opportunity to grow your money further but there’s a chance it will decrease in value too. Another risk is that without a guaranteed income, you’ll run out of money to support you throughout your later years of retirement.

If you currently have additional benefits as part of your pensions scheme, such as a spouse or child pension, you’re also likely to lose these when cashing out too.

You’ll typically have to seek financial advice before cashing out of your Defined Benefits pension, if it’s a move you’re considering, we can help address concerns you may have and offer guidance.

Staying in: Remaining part of your Defined Benefit scheme is more straightforward but that’s not to say it’s without drawbacks.

By staying in, you’ll benefit from a set income that gives you a level of certainty and stability throughout your retirement years. If financial security is important to you and your Defined Benefits scheme will make up the majority of your retirement income, for example, it can be an attractive option.

On the other side, there are, of course, disadvantages too. If you have big plans for your early retirement years, such as travelling to the destinations you’ve always wanted to or investing in a second property, a lump sum can better fit into your plans.

The other concern, as mentioned above, is that some funds are operating at a deficit. This may mean that some employers do not have the money to pay the pensions they’ve promised. In the past, schemes have gone bust, including Carillion and British Steel. While the Pension Protection Fund might be able to offer compensation if this happens, it’s not guaranteed that it will match the full amount you’ve accumulated.

Ultimately, which option is best for you will depend on your plans for retirement, what other assets you have, and your appetite for risk, as well as the details of your Defined Benefit scheme.

Whether you’re leaning towards transferring your Defined Benefit pension or plan to take an income from it throughout retirement, seeking financial planning expertise can help you understand how you’ll be affected. Contact us today to talk through your options and any offers you’ve been made.

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