How they work:
Your pension entitlement within a Defined Benefit/Final Salary scheme is calculated based on your pensionable salary and the length of time you were a member of the scheme/employee of the company. You will normally be required to contribute to the scheme whilst an active member, with your employer being responsible for making up the difference of the cost required to provide your pension at retirement, whatever that might be. With this type of pension scheme, the investment risk therefore sits with the employer/sponsor, unlike Defined Contribution schemes where the investment risk sits with the member.
When you retire, you will be paid the pension due to you under the scheme, and in most instances, the pension will increase in payment each year in accordance with the scheme rules/legislation.
Defined Benefit Transfers Explained
A defined benefit transfer allows you to exchange your future pension entitlement in a Defined Benefit/Final Salary scheme for a cash sum known as a Cash Equivalent Transfer Value (CETV) that has to be paid into a registered, HMRC recognised pension scheme.
The value of the CETV is the ‘cash equivalent’ in today’s terms of the pension income you would have been entitled to had you remained a member of the scheme.
The process of calculating a transfer value is done by the scheme actuary based on specific guidelines. The calculation is a function of:
- How far away from retirement you are.
- The level of pension you were entitled to when you left the employer.
- How the scheme rules state your pension will be increased between your date of leaving the scheme and when you retire, and how it will increase in retirement.
- The level of any widow’s/widower’s benefits and guaranteed periods.
- How long you might be expected to live.
- The future investment returns that can be expected on the funds set aside to meet your pension liabilities.
If you decide to transfer your CETV, your entitlement under the Defined Benefit/Final Salary scheme will be fully discharged, and you will have no further claim on the scheme. The transaction is not reversible, so you cannot buy your way back into the scheme. This is therefore a decision which requires both very careful consideration and expert financial advice.
Please speak to one of our advisers on 0800 122 3240.
Impact of Pension Freedoms Legislation on choices at retirement
On the 6 April 2015, the government lifted the restrictions on people’s ability to draw down from their defined contribution pension pots after age 55. The tax rules are simpler to give people unrestricted, flexible access to their pension savings.
This also applies to anyone who transfers from a defined benefit arrangement into a defined contribution plan.
The government no longer prescribes a particular product which people are required to purchase or invest in when accessing their savings. It is up to individuals to decide how they want to access them, either as a lump sum or through some sort of financial product:
- Those who want greater control over their finances in the short term can extract all their pension savings in one go, and invest/spend them as they see fit.
- Those who continue to want income security can purchase an annuity, either at the point of retirement, or at a later stage.
- Those who would prefer to draw from their invested pension funds can access them over time using a drawdown product. However, unlike the previous system, there will be no limits on the amount someone can withdraw from their drawdown arrangement each year, and there will be no minimum income requirement which people have to satisfy in order to withdraw from their pension.
Apart from the tax free cash element of the pension fund (usually 25%), any funds withdrawn are now taxed as income at the individual’s marginal rate(s) of income tax.
Your Pension Options
It’s good to have choices when it comes to pensions and your retirement, but it’s also important to understand all your options from age 55 onwards.
Under a Defined Benefit or Final Salary plan you build up a certain amount of pension for every year of pensionable service.
Take your scheme pension
You will be paid a set amount every month for the rest of your life, so you will know exactly how much you are getting and when.
Transfer to a Defined Contribution plan
By taking a transfer to a Defined Contribution plan you will be able to take advantage of the Pension Freedoms flexibilities. This may be advantageous if you have different requirements for your retirement.
What can I do with my AVCs?
You have a number of options when it comes to your Additional Voluntary Contributions. These are scheme specific and you will need to contact our administration team to understand your options.