People with final salary pensions are switching out of them in increasing numbers, and the experts are worried. They warn that a switch may come back to haunt people in their retirement, and that the flood of members out of these schemes could kick-start the next pensions scandal.
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There's growing evidence that defined benefit pension scheme members are increasingly being persuaded to leave their scheme. Scottish Widows, for example, has reported a 170% increase in requests for transfer value analyses, compared to the same period last year.
Tom McPhail, Head of policy, Hargreaves Lansdown warns: "We are concerned by the risks to investors who may give up a guaranteed pension from a final salary scheme in exchange for cash now, only to regret it later."
What's going on?
It's easy to see why people are tempted. They are being offered what appear like substantial transfer values by their DB scheme. They also know that if they transfer the money, then they can take as much of they like out of the pension as a lump sum once they reach the age of 55. McPhail says: "In this post pension freedom world, and with pension transfer values at record levels, it is very easy to be persuaded by the lure of short-term cash."
The risk is that people are swayed by the size of the cash value, without realising that it isn't sufficient to compensate for the guarantees they are giving up. If investments underperform, or they live longer than they expect, then there's a real danger they could run out of money.
If you are lucky enough to be in a defined benefit scheme, therefore, McPhail says there are a number of questions to ask yourself before you consider switching to a defined contribution scheme.
1. Is there something about the scheme that fundamentally doesn't fit with your objectives? It may have inflexible and unsuitable death benefits, for example, or you may need more flexible income withdrawals for tax planning purposes.
2. Is the future of the scheme at risk? Some investors are concerned about defined benefit scheme deficits and the risk of employer failure. Whilst the Pension Protection Fund provides a lifeboat scheme, it doesn't guarantee full compensation so there is an understandable concern among some investors at the risk of possible loss of guaranteed benefits. If the scheme is particularly vulnerable it may increase the arguments for a transfer.
3. Are you prepared to take on the investment risk? The money freed up from a transfer is usually invested. Anyone making the switch needs to appreciate the risk that this will not grow as expected, and the implications that this holds for retirees - who could end up with significantly less money then they had hoped.
4. Can you afford to take the risk? If you make the transfer, and the investments do not perform as expected, will you be able to pay for the essentials? If not, you should not transfer.
5. Can you match DB growth? If you're not going to take the benefits immediately, do you know how much the investments would have to grow in order to keep pace with the pension you would have had from your defined benefit scheme? Is that realistic?
This is a serious decision, with a huge number of variables, so it makes sense to take professional advice. Many providers will not actually allow a transfer unless you have been advised, because the risks are simply so high.