Final Salary Pension Transfers – to DB or not DB?

I know, the title is a little cheesy but the subject definitely isn’t.

There’s been a lot of these transfers done in recent years, not just here on the Isle of Man but throughout the UK in general. The main reason is because the amount of money on offer is probably more than most people would ever save in a pension during a lifetime, so it makes sense to move it where it can be flexible and accessible – doesn’t it?

Well, maybe…

Firstly, a little word on critical yields.

Critical yield is basically the annual growth you would need in a non-DB pension in order to provide the same amount of cash to purchase similar benefits (via an annuity) at retirement as you would have received had you not moved out of the DB scheme – makes sense?

Nope? Well, join a cast of thousands.

It’s not just that this often complex calculation is hard to explain, but it’s also increasingly out of date and was perhaps more fitting for a time when the only alternative to a DB scheme was to purchase an annuity – but even my (recently) retired Mum knows that we have moved way past that time.

What is more surprising is not that this calculation is still carried out (in fact it’s a legal necessity in the UK, but just best practice on the Island), but that its results are still held up by some as being the cornerstone of any decision to transfer.

It shouldn’t be – let me explain why, which sort of brings me to my second point;

Transferring out of any DB scheme comes down to a choice between guaranteed (and potentially) inflation-proof benefits and flexible benefits (some more flexible than others, but that’s another blog) which are not guaranteed.

However, wrapped up in this decision are lots of other important factors;

  • Health issues – are you unwell or does your family history mean that potentially you may not see much of your DB benefits?
  • Dependents – do you want to pass on your benefits to your spouse and children or does your scheme offer you an excellent death bereavement package?
  • Debt management – would being able to pay off your mortgage or debts (via a flexible arrangement) benefit you more now than when you reach your schemes retirement date?
  • Income requirements – do the scheme’s income levels fulfil your early retirement income objectives or do you require more income in the early years and maybe less later?
  • Cash – what amount of tax-free cash does the scheme offer compared with a flexible arrangement?
  • What is your attitude to risk? – flexible arrangements must be invested to keep pace with inflation and this may not fit your tolerance for loss.
  • Scheme funding position – is there a big black hole and what would happen if your pension provider can’t afford to fund your pension in the future?
  • Charges – in flexible pension arrangement’s you must bear all of the charges.
  • Complexity – flexible arrangements can be complex – DB pensions are relatively simple.

I could go on, (believe me, I really could) but I think you are getting the picture.

Critical yields deserve discussion but they’re only one part of what should be a much wider discussion on flexibility versus guaranteed benefits – especially at a time when most people will not consider an annuity on the Island due to its obvious restrictions (again, that’s another blog).

In a perfect world, a mix between both guaranteed inflation-proof income and something more flexible might be the perfect combination, because this covers a lot of bases. In many cases this can often be achieved between a couple where each person has separate pension arrangements.

So basically, there is no single factor that should either swing your decision one way or the other, but rather a whole combination of factors, with your default position starting with you remaining in the scheme.

Remember though, just because this is where you should start doesn’t mean staying in your current scheme is the correct choice for you; after all, we presume people are innocent before trial, and all the evidence is reviewed, but jails are still full.