George is a 55-year-old director of two small to medium-sized enterprises. He previously worked for a FTSE 100 company where he built up a generous defined benefit (DB) pension. He would like access to the tax-free cash sum available from his DB scheme but he does not need the pension income.
He is likely to work another 10 years and pays the top-rate income tax. He has paid off his mortgage, has some other ISA savings and values his shares in private companies at around £1.5 million. He always assumed he would take his tax-free cash and pension directly from the company scheme at 60. But is there a better solution?
Generous transfer values
Staying in a final salary scheme makes sense for the majority of deferred pensioners. However, transfer values have become more generous and the options for withdrawing benefits from a personal pension are more flexible than ever. There are circumstances when transferring can make sense.
Transfer values reflect annuity costs, which are inversely proportional to gilt yields: as gilt yields fall, transfer values go up. For a typical DB scheme paying benefit increases of 3% per year, deferred benefits have gone up by around 20% over the past six years while transfer values have risen by around 80%.
However, this trend will probably not continue in the future. Gilt yields are now at rock bottom and many warn of a potential price bubble. If gilt yields start to rise, transfer values will fall. So the trend does not mean everyone should transfer: a high transfer value in itself is not a sufficient reason to move.
Considering the pros and cons
If George needs the security of a guaranteed lifetime pension, he should probably stay put. The increase in the transfer value is matched by the increased cost of buying this guarantee outside the scheme. Thus there is little to be gained besides more risk.
Then again, George may not trust the employer to keep funding the scheme or he may be in bad health. But the people who have the most reason to transfer are those who are happy never to buy an annuity and who want more flexible benefits.
George’s situation makes him a potential candidate for a transfer: he can take the tax-free cash now and defer his pension income. He can phase in his pension income as and when he needs it and he can keep it variable year by year to be tax-efficient.
He might also like to have a residual fund to pass on by only spending income and not the capital from the transfer. Or he might like to use the flexible drawdown rules and take most of his benefit as a cash sum.
Limiting risk and beating inflation after fees should be a prerequisite. Having other assets or income to fall back on takes the risk out of longevity. Taking a transfer is a complex irreversible transaction. Generally, the transfer value is guaranteed by the scheme for three months. Pensioners should use this time to make sure it is the right option for them.
James Baxter is managing partner at Tideway Investment Partners.