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Business matters: Defined benefit/ final salary pensions

More than £50bn has been taken out of ‘gold plated’ final salary schemes over the past two years. Tim Venner looks at the drivers of demand and if we have already reached a peak.

Tim Venner

in Features


A study commissioned by the Financial Times over the summer found that 210,000 members have opted to transfer out of their defined benefit (DB) pensions in favour of taking a lump sum. It may be tempting to attribute this surge in demand to rising transfer values but this overlooks a key change to the rules which is the real driver.

Those familiar with the current situation will know that the number of people opting to cash out their DB pensions has been partly attributed to pension providers offering larger sums of cash in exchange. Following the EU referendum, government bond yields plunged to record low levels. When gilt yields are low, it pushes up long-term liabilities for pension trustees and 15-year gilt yields fell from over 5% in 2008 to almost 1% by the end of 2016. If it costs more for a provider to run a pension scheme, it is in their best interests to incentivise members to cash out.

In fact, pensions actuarial Xafinty shows these transfer values reported a steady increase in transfer values over August and are significantly up on the values reported for the beginning of the year.

While larger cash sums on offer will inevitably tempt more people to consider transferring their final salary pension into a defined contribution, there is far more at work here than this. The transfer values may prove a fleeting phenomenon but they mask the real driver of demand – changes to the rules surrounding defined contribution (DC) pensions.

In April 2015, the compulsory requirement to ultimately use an annuity to provide pension benefits was abolished.  Since then, individuals aged 55 and over have been able to access their DC pension savings as they wish, subject to their marginal rate of income tax. This has been well received by individuals who do not need the secure income for life provided by an annuity.

The most recent figures from HMRC showed that 200,000 individuals cashed in £1.8 billion as they took advantage of these new freedoms in the second quarter of 2017, representing the largest amount withdrawn since 2015.

The evidence would also suggest DC pension holders prefer taking lump sums. The Financial Conduct Authority (FCA) recently conducted a study of the retirement income market which discovered that not only has accessing pension pots before age 65 become “the new norm” but that the majority demonstrated a preference for lump sums rather than a regular income.

The other game-changing element of the pension freedoms was the change to death benefits. If you die before age 75, then your DC pension is left tax-free to your person of choice. Previously, you would have been hit by a 55% tax rate. And whether or not you die before or after age 75, pension funds do not form part of your taxable estate for inheritance tax purposes. This  offers an opportunity for generational planning which is not available to most DB pension scheme members.

The main impediment to demand is simply that cashing out a DB pension is not in everyone’s best interests. This is by no means a straightforward decision and it is also irrevocable. There is a reason that the regulator requires savers to seek professional advice before transferring a pension valued in excess of £30,000. Even this has not been enough to completely guarantee protection for savers and the regulator has even moved to ban a number of advisory firms from carrying out pension transfers.

The amount of money that savers have already chosen to move from DB to DC pensions is staggering but this could well just be the beginning. Regardless of what happens to transfer values, for some, the pension freedoms will continue to provide a compelling case to consider making the switch.

Nothing on this website should be construed as personal advice based on your circumstances. The taxation of pensions depends on your personal circumstances and may be subject to change in future.

No news or research item is a personal recommendation to deal and we recommend that you seek advice concerning suitability from a regulated financial adviser.

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