Final Salary Schemes – Is that your Final Answer?

Some holders of final salary schemes may consider transferring out of them to take advantage of the pension reforms. But would this be a good idea? Anyone considering this irreversible step could soon be required by law to take independent financial advice first. Here’s why.

When you’re offered a lot of money in one go, there’s a temptation to take it and run. But it’s not just game show contestants who face this tricky choice. The new pension freedoms have given us all some tough questions to answer, and none more so than the holders of final salary (aka defined benefit) schemes.


Q: What’s different about a final salary (FS) pension scheme?

A: Unlike a defined contribution (DC) pension, an FS pension is not dependent on a fixed pot of money built up over time. Instead it provides a guaranteed income from the date of retirement until death, much like an annuity.


Q: Does that mean an FS scheme is better?

A: They have tended to be seen as better, yes. It would take an above-average DC pension pot to buy an annuity that could rival the average FS scheme.


Q: But now people want to trade them in?

A: Apparently some do. Since the Budget, some pension providers have seen double the number of customers cashing in their pensions, and a recent survey found that up to half a million holders of FS pensions were planning to transfer out of them.


Q: Why?

A: Short answer: the pension reforms. These apply only to DC schemes, so if people want such freedoms as being able to withdraw large lump sums, or pass on funds to beneficiaries on their death, then they would need to transfer their FS pension to a DC one.


Q: But isn’t that a good idea?

A: There are some arguments in favour. It might allow people to settle debts, for instance, or buy extravagant treats in their retirement – or bequeath more money to loved ones in their will. If someone has only a small FS pension that would provide a low guaranteed income, it may make more sense for them to transfer out. But those with larger FS pensions could live to regret any decision to cash them in.


Q: Can I phone a friend?

A: Of course you can. In fact, you will probably have to. The Pensions Regulator is pressing the government to make it compulsory to seek financial advice if you want to cash in an FS pension with a transfer value of £30,000 or more. Previously, it was even proposed that such transfers be made illegal – that is how worried the government has been about this issue.


Q: What’s the big risk of trading in my FS pension?

A: Remember that up until now, FS schemes have been the envy of other pension savers. You would be trading in a guaranteed lifetime income for a fixed sum (which may not be anywhere near as large as the total amount you would have otherwise received over time). In other words, you would be introducing a new uncertainty into your circumstances: uncertainty over whether your pension will last as long as you live. A solid rule of thumb in financial planning is to reduce uncertainty wherever possible, not increase it.


Q: If I transfer out of my FS scheme, can I change my mind?

A: As things stand, no you can’t. David Smith, financial planning director of BestInvest, has called for the Pensions Regulator to make its mandatory advice rules retrospective, to allow those who have already transferred FS schemes to reverse their decisions. But at the moment, any decision counts as your final answer.

Q: Is the law already in effect?

A: Not yet, but it’s expected to be in place by the time the freedoms are launched in April 2015.


Q: Do I still need advice if my FS scheme is worth less than £30,000?

A: The law may not require you to take advice, but it is strongly recommended that you seek it anyway. To quote David Smith, ‘That small end of the market arguably needs more protection than the top end of the market because it’s all these people have got.’


Q: Will free guidance from Pension Wise be enough?

A: Definitely not in this case. If you’re considering any transfer of an FS pension scheme, you must (or should, if it’s valued at under £30,000) seek independent financial advice first.


Q: I’m not sure of the value of my pension. How can I check?

A: Your latest annual statement should have this information.