If you were offered £235,000 now or an inflation-proofed £10,000 a year for the rest of your life, what would you choose?
This is a similar dilemma faced by many Britons with ‘final salary’ or ‘defined benefit’ employer pensions, as those figures represent today’s average pay-out for members who forfeit their pension benefits for a one-off sum.
Final salary pensions pay a minimum income throughout retirement, usually with yearly cost-of-living increases, until the member dies. Benefits then usually pass on to the spouse at a reduced rate for their lifetime. As such, they are considered highly valuable, even ‘gold-plated’ pensions.
Although the high transfer values offered in exchange for giving up future benefits can be tempting, the UK’s Financial Conduct Authority stresses that most people are better off staying where they are.
While there is no right or wrong approach here, it is essential to take extreme care before making major pension decisions. Start by considering six key questions.
1. What is your pension worth?
The £10,000-a-year example sounds low but could well be enough to provide for a modest retirement, especially when combined with other savings and income. But a one-off sum of £235,000+ could also provide an adequate retirement income if properly managed over time, with potentially more flexibility around withdrawals and currency options.
If you are considering a transfer, be mindful of the UK lifetime pension allowance (LTA). If combined UK pension benefits (excluding the State Pension) breach the 2019/2020 limit of £1.055 million (previously £1.03 million), charges of 55% on lump sums or 25% on income applies on the excess, even for non-UK residents.
The default transfer value for final salary pensions is 20 times the annual retirement income, which means LTA penalties are usually triggered when transferring pensions worth £52,750+ a year. However, this does not factor in other pension benefits and will obviously decrease with more generous transfer values.
2. Do you have other resources for retirement?
The UK State Pension currently pays a maximum of around £8,700 a year, so most people need something extra to see them through. Is your pension transfer value high enough to outweigh the benefits of drawing a guaranteed income for life? Or will your other pensions, savings and investments provide for your future? If so, you may be more inclined to forfeit a final salary pension for a one-off reward.
However, if your final salary pension is a large part of your retirement wealth, the certainty of a regular lifetime income will hold more value.
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3. How long do you need it to last?
Final salary pensions provide income for as long as you live – with today’s increased life expectancy, that could be 30 years or more from retirement age. Those in good health may benefit more from a guaranteed lifetime income; the opposite may be true for those who do not expect to outlive their resources.
4. How stable is your pension scheme?
Many final salary employers are struggling to meet their obligations. Benefits are usually financed through investments in UK bonds, which have generally under-performed through years of low interest rates. With higher-than-ever life expectancy – meaning benefits must be paid for longer – plus Brexit uncertainty, many are facing significant shortfalls.
The government’s Pension Protection Fund (PPF) found that 3,117 schemes were in deficit at the end of February, with a combined shortfall of £8.6 billion.
While the PPF offers a safety net, it currently only compensates up to £40,020 a year at age 65. If your pension is high value and your scheme is vulnerable, take regulated advice on whether transferring may be in your best interests.
5. What will happen when you die?
Most final salary pensions will transfer half the value of the pension to your spouse on death – then go no further. Transferring funds could unlock more estate planning flexibility, such as the option to pass pension funds to other heirs, even across generations, and potentially even reduce inheritance tax liability.
6. What do you want to do with your funds?
Clearly, anyone transferring their pension for extravagant purchases, like a sports car or luxury property, may leave little left for retirement expenses. However, any kind of investment comes with risks.
Benefits in a final salary pension are protected – even if the value of funds goes down, the scheme provider is obliged to make the guaranteed payments.
Once transferred, you gain more control over how you invest and access your funds, and can take advantage of tax-efficient opportunities for Spain. However, your money is no longer safeguarded and becomes vulnerable to unpredictable markets. Even money in the bank can be eaten away as inflation outpaces returns in this low interest rate climate. While investments can obviously go up as well as down, without proper guidance you risk losing everything to unregulated investments or pension scams.
Whether you should transfer a final salary pension depends on numerous factors and your unique set of circumstances and goals. Taking regulated advice is compulsory if you have benefits worth over £30,000, but it is an important step for anyone considering their pension options.
Remember: once you transfer your pension, you cannot reverse your decision. Take locally-based, UK-regulated advice to fully understand the long-term implications and establish what is best for your financial future in Spain.
For more information and personalised advice, contact Blevins Franks on +34 971 719 181.
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This article was written on the 1st of June, 2019.