Defined benefit transfer: Should you draw down your pension?

Thinking of transferring out of your pension? Demand to draw down defined benefit pensions at an all-time high, but there are some downsides to consider.

Love Money
Last updated:05 February 2018 - 07.01pm

Over the past few years, defined benefit (DB) pensions have been considered the gold standard when it comes to retirement savings vehicles.

Typically these schemes are offered by one's employer pension scheme, and are calculated by your years of service and either your final salary or a career average with the company. 

So for example, each year you might accrue 1/60th of your final salary with the firm towards your pension.

However, these are incredibly expensive pensions to maintain for employers, which is why very few still offer them.

[Read more: Retire a millionaire – how saving a small amount adds up]

Instead, employers will generally look for you to take out a defined contribution (DC) pension, where you, the employer and the government all contribute a set amount.

This money is then invested, which you can eventually use to buy an annuity that will deliver an income for life, or else keep it in invested.

The accepted thinking for a long time has been that it’s a bad move to switch from a DB scheme to a DC scheme – you’re giving up guaranteed benefits to do so.

However, over the last couple of years there has been significant demand to do so.

This week we have seen the FCA launch a consultation to review the guidance it sets out for financial advisers on how to help people who are interested in doing so.

Do you have to be mad to switch? Why do so many people want to do so? We reveal all.

Why pension savers are tempted to switch

There are a number of factors making a move from a DB pension over to a DC pension an attractive option at the moment.

The first is straightforward flexibility.

A DB pension is pretty rigid in its structure – you get a set amount of money every month until you die, and there are no real allowances for how your needs might change throughout retirement.

For some savers, that’s not ideal – they might plan a more active couple of years initially, so need more of their pension pot available, or they might prefer to keep as much of it locked up as possible to cover potential care costs.

The introduction of the pension freedoms a couple of years ago gave pension savers vastly more control over just how they access their pension cash – and how they can use it.

But these freedoms are only open to people in DC schemes, not DB ones.

Having control over the pension pot they have worked hard to build is an attractive thought.

Another factor at play are the transfer values being offered for defined benefit pensions at the moment.

These have been pushed up as gilt yields have fallen – essentially this makes it more expensive for the DB scheme to meet its obligations to its members.

And these values really have shot up. Pension firm Xaffinity tracks the transfer value, which would be provided by an example DB scheme to a member aged 64 who is entitled to a £10,000 yearly pension, starting at 65.

Last June that pension saver could get £210,000 as a transfer value – today that has rocketed to £241,000.

But with talk beginning again of potential interest rate rises on the horizon, the argument to move and move now becomes a bit more compelling.

If interest rates go up, gilt yields likely will as well, and so transfer values will fall.

The final big factor here is uncertainty about how secure a pension scheme really is.

David Blake, director of the pensions institute at Cass Business School, warned that around 1,000 pension schemes “are in a very precarious position with financially weak companies behind them or large deficits”.

Certainly, we’ve already seen a handful of high profile failures recently – just think of the BHS debacle – and while they are very much the minority, that uncertainty has increased interest in moving away from a DB scheme.

The downsides to switching

However, there are plenty of considerations for savers looking to switch.

The most obvious is that not only are you giving up value in your pension in return for a bit of flexibility, but an income that is guaranteed.

On top of that, you are taking on far more responsibility for your own saving.

Alistair McQueen, pension policy manager at insurer Aviva, explained: “You get real peace of mind and certainty from a DB scheme; the responsibility sits with the pension scheme, so someone else is looking after everything for you.

“If you take your money into a DC scheme, then you have the responsibility of how and where to invest it to ensure it will provide for you for the rest of your life.

“Most of us understandably lack the confidence to do this.”

It’s also to remember that that guaranteed income will increase in line with inflation too.

With inflation expected to increase in the coming years, that’s another very important selling point.

How to transfer your pension 

If you decide you want to transfer out of your scheme, here’s what you need to do.

Get a quote

The first step is to go to your pension scheme and ask them for a transfer value quote. The trustees will generally honour this quote for six months.

Find an adviser

Now you need to find an adviser willing to help with your case. As always with financial advice, the Unbiased website is a good place to start.

The adviser will get all of the details for the scheme, and then go through your attitude to risk and investment to establish whether a transfer really is right for you.

They will then give you a personal recommendation on whether to transfer or to stay where you are.

Decision time

Even if the adviser tells you that you should not transfer, you don’t have to follow that advice. You can still go through with it, and you will be classed as an ‘insistent customer’.

Be warned here, not all advisers will carry out a transfer on behalf of an ‘insistent customer’, and some providers are nervous about accepting them as customers too.

[Read more: How to invest pension freedom cash for low-cost growth]

Carrying out the transfer

Your adviser will carry out the transfer on your behalf, handling all of the important documentation.

They will likely provide ongoing advice around how to invest and how to take an income from your fund.

And there you have it.