Occupational pensions have been in the news recently for a number of reasons. First, the near collapse of the BHS pension scheme. Then the Government plan to make it easier for employers who are struggling to maintain pension promises to water down their pensioners’ benefits.
Add in the fact that the terms on which employees can transfer out of schemes are currently unusually favourable and that in April the ‘exit’ charges for members wishing to transfer from occupational schemes to Self-Invested Personal Pension schemes or other ‘defined contribution’ schemes will be capped at 1%, and it is little wonder that an increasing number of members of occupational schemes are considering transferring.
This would enable them to enjoy the benefits of the so-called ‘pension freedoms’, including unrestricted access to benefits as from the age of 55 and inheritance tax advantages. But would transferring be the right thing to do?
Before the financial crisis or 2008 it was confidently assumed that the greatest advantage of final salary schemes was that the benefits were guaranteed. However, following the BHS scare, employees have come to realise that a guarantee is only as good as the guarantor – i.e. the sponsoring company.
There is, however, a government ‘lifeboat’ scheme, the Pension Protection Fund, which underpins pension entitlements. Pensions up to £10,000 are likely to be protected, but the scheme would not cover scheme pensions over £37,420 per year.
Apart from the question of the guarantee, what are the other factors affecting the decision as to whether or not to transfer?
First, there is the question of risk. The value of a defined contribution scheme depends on the value of the scheme investments, which depends on the stock market. The employee, rather than the employer, shoulders this risk.
The value of death benefits would be another consideration. Occupational schemes include widows’ pensions and a lump sum payment on death in service.
Under a defined contribution scheme, life cover would have to be paid for separately, so individual family circumstances would be another factor in any decision.
Financial advisers usually take as their starting point that transfers will only be appropriate if there are real doubts about the viability of the occupational scheme. But if it seems that there could be a case for moving, the adviser will usually conduct a ‘critical yield’ analysis to determine what return would be required from the new scheme to match the benefits of the occupational scheme.
This analysis involves making assumptions on a number of issues, including the possible course of interest rates, stock market returns and personal health and family responsibilities.
The prediction of income would then need to be related to an analysis of likely expenditures, which would involve the use of cashflow forecasting software. However, there can be no guarantees that events will turn out as predicted. Hence the reluctance of financial advisers to recommend transfers.