Should you cash in your final salary pension?

Have you got a final salary pension? If you do, you should consider yourself very lucky! Just 19 companies on the FTSE 100 stock exchange still offer them so they are a bit of a rarity these days. 

Recently, lots of people have been rushing to cash in their final salary pension but why is that?

What is a final salary pension

Just in case you didn’t already know. A final salary, or defined benefit, pays a guaranteed retirement income for life, based on how much you earned and how long you worked at the company for. Pay outs can be generous, and it’s certainly a more reliable prospect than the alternative defined contribution schemes which rely on stock market returns to fund your retirement.

But a final salary pension generally doesn’t offer the flexibility of a defined contribution plan. And that’s tempting people to cash them in.

In 2017, the amount transferred from final salary pensions to defined contribution plans rocketed up from £7.9bn to £20.8bn. That’s 92,000 transfers at an average of £250,000 each.

What does cashing a final salary pension in mean?

Essentially, you’re transferring money out of your company plan and into a personal pension pot. You can then invest it wherever you like. Or, if you’re over 55, you can simply withdraw cash from the new pot and spend it on whatever you like.

Why are more people cashing in now?

In 2015 pension freedoms were introduced by the government. It gives those over the age of 55 the flexibility to take their pensions as cash instead of an annuity. An attractive option for people who do not want to be tied down to an annual income. 

In addition, transfer values being offered on defined benefit pensions have been at record highs. A combination of low interest rates and low gilt yields has caused this rise in transfer values. When interest rates fall, it can become more expensive for companies to buy the investments which pay pensioners their guaranteed incomes. So bosses are keen for workers to cash in, and offer bigger incentives to get them to do so.

People are being offered sums far above their annual pension to transfer, making it an appealing offer.

However, yields have begun to rise from these historical lows, and we’ve seen the first interest rate rise for a few years. The impact may be that schemes begin to reduce the amount they offer people to transfer. So now could be the right time to take advantage of the offers, before they start to drop. 

But just because you can doesn’t mean you should!

When might it be a good idea to cash in a final salary pension?

Immediate access to a lump sum of money might be too tempting for some people to resist. But that alone is a very poor reason to make the leap, particularly if you don’t have any other guaranteed incomes. 

However, there are some circumstances which may mean this is something to consider.

• If you have children(or other beneficiaries), they stand to receive nothing under a defined benefit scheme. They can, however, inherit funds under a defined contribution scheme tax-free if you die before you’re 75. If you die after 75, the fund will still pass on, but will be subject to tax.  
• If you’re sick,a lifetime income isn’t much use to you if you’re not going to live long enough to receive it. A transfer might be a better option if you’re a heavy smoker with a family history of heart disease!  
• If you’re worried about the scheme collapsing. Pensions schemes are costing companies as much as 40% of payroll, three times more than 30 years ago. This has led to lots of pension schemes in the red. If an employer goes bust, the Pension Protection Fund steps in to compensate, but pay outs are likely to amount to less than they would have done. As BHS employees, and more recently Carillion employees, found out to their detriment.  
• If you need more flexibility. Under a defined contribution scheme you can spread withdrawals and reduce your tax bill. But you are also responsible for making sure you don’t run out of money.  
• If you need access before you’re 65 (the age at which most final salary schemes will start to pay out) – with most defined contribution schemes, you can access funds at 55.

Why might you be better off sticking with your final salary pension?

• With no guaranteed income for life, you put yourself at risk of running out of money before you die.  
• With a defined contribution scheme, you’re at the mercy of the stock market. The value of your fund could fall, leaving you with less to live on. A final salary pension doesn’t have this risk.  
• With final salary pensions, pay outs rise with the cost of living, so you have some protection from inflation.  
• If you have a spouse (particularly one who’s younger and fitter with no retirement income of their own), a final salary scheme may hold value for them too, typically 50% – 75% of the original value.  
• There’s no going back! Once you’ve transferred out, you can’t transfer back in, so it’s not a decision to be taken lightly!  
• If you’re offered more than £1.03 million to transfer, this will push you over the lifetime pension limit and you’ll be charged 55% tax on anything over that value – something to bear in mind.

What next?

The best thing to do it get some advice!  The FCA has made this a condition of being able to transfer a fund worth more than £30k. Transferring from a defined benefit scheme to a defined contribution is irreversible, so it’s worth it no matter what the size of the fund to avoid making a mistake you will later regret.

Everyone’s circumstances are different. Getting advice means you can be confident you’re doing the right thing for you and your family.