Defined Benefit Transfers - Not what they seem...

Defined Benefit Transfers  

Not what they seem...

So, you’ve got an old defined benefit (DB) occupational pension scheme and they are politely offering you a large lump sum to move on. Should you take it? It’s a large, life-changing amount of money, but is it good value? Unfortunately, in the world of occupational pensions, all is not always what it seems. 

The starting position should always be to assume a transfer out of the old scheme is not a good idea. That’s because most schemes offer valuable guarantees that can’t be replaced by an alternative, private pension. For example, the income in retirement will be guaranteed, most likely with indexation and spouse’s benefits. In some cases the rate of income will be so good, it’s unrealistic to expect a personal pension to replace it on a like for like basis. 

And it’s that like-for-like comparison that’s so important. Take the example of a DB scheme offering a guaranteed pension income of £12,000 per year or a lump sum transfer value of £400,000. On the face of it, that looks straight forward. The £400,000 could be invested and would only need to return 3% per year to match the income given up. The problem is that’s not a like-for-like comparison. The old scheme’s income was guaranteed, not only on day one but throughout life, increasing by RPI each year. In addition, on death the spouse would then have a guaranteed income for life, also indexed. If the lump sum was taken, the resulting income would fluctuate with the markets, as would the original capital, potentially losing value over the years. However unlikely that might seem, it must be taken into account when comparing the two options.  

As should your preference if you die. With the DB scheme, your partner will receive an income for life, but with a personal pension they receive the whole lump sum. Again, that sounds good, but is it enough to entice you away from the guaranteed income? 

Of course, everyone is different. You may not need the guaranteed income and are happy investing or you may like the idea of your partner receiving the whole lump sum on your death. The point is there are many things to consider when weighing the pros and cons of a potential transfer so don’t be blinded by the large lump sum on offer. Think about what’s important to you and your next of kin. What benefits would you be giving up or what risks are you willing to take with the lump sum? And above all, take advice!       

Craig Davidson 

Davidsons IFA