Transferring a final salary scheme can be a great move
UK Defined Benefit Schemes or final salary schemes have previously been common in the United Kingdom, although more recently many employers have been phasing them out.
UK defined benefit schemes set the level of benefits that will be received in the future (i.e. the scheme offers £10,000 a year for a member when they reach retirement). The level of benefits will usually be a function of your length of service and final salary.
Because UK defined benefit schemes set a level of future payments the valuation of the scheme prior to retirement is defined by a series of complicated factors, including:
- Length of time until retirement starts
- Average life expectancy of all members in the scheme
- Current and future projected interest and inflation rates, to name a few
There has been much written, in the UK, about the fact that in the majority of instances transferring out of UK defined benefit schemes into a Personal Pension Schemes (PPS) is more often than not a bad move. We do not question that line of thinking for inter UK transfers when you live in the UK. This is because in the UK when you transfer out of UK defined benefit schemes it will be into a PPS and you will typically lose all the benefits of the UK defined benefits schemes, such as inflation indexing, partner benefits on your death etc.
The arguments for transferring out of UK defined benefit schemes into a UK PPS are:
- You are no longer exposed to the risk the company scheme will dissolve in the event the company fails (although the Pension Protection Fund has been set up to reduce this risk)
- You take investment control of your own funds
With a transfer to New Zealand the swap is not like for like
If the member of a UK defined benefit scheme has moved to out of the UK they need to consider a slew of other factors, including:
- Exchange rates
- Tax consequences in both jurisdictions
- Investment options
- Current valuation levels of the members UK defined benefit scheme
Exchange rates are fickle – meaning your benefits are hardly defined
If you end up getting an annuity from your UK defined benefit schemes you are at the mercy of currency fluctuations between the British pound and your country of residency’s currency such as the New Zealand or Australian dollars. This means in some years your income may be higher than others (you only have to look at the performance of the New Zealand dollar to the pound over the last 20 years which ranges between $3.5 to a pound to $1.85 to a pound). This puts considerable stress on you as you are unsure of how much income you will be receiving year on year – hardly defined benefits.
The tax consequences of leaving a pension in the UK are high
In most countries when you receive a foreign pension you pay income tax on it in the country you live in. If you live in New Zealand, for example, any UK pension lump sum will be taxable (ranging from 0% to 33% in tax) and the remaining income will be taxable at your marginal rate. Meaning that at least 75% (i.e. the non lump sum payment) will be taxable as income at a rate of up to 33% – this is the equivalent of paying 24.75% on the value of your pension fund. You will need to read the section on tax to understand how you might mitigate this tax burden through a pension transfer.
Investment options in defined benefit schemes are non-existent
While this is a tested argument in the UK, that is, the scheme can manage the finances better than the individual (so don’t give up your benefits and transfer out) it is often not the case when you live overseas.
You end up with little investment control and what’s more the decisions on benefits are made in a country where you are no longer resident. Having control over the investment in a region in which you understand what is going on is crucially important. You cannot be expected to live and breathe changes in UK defined benefit schemes (the list of which have been enormous over the last two years alone – such as two recent changes to recalculation methodologies for government pensions).
Valuations of UK defined benefit schemes are high
The valuations of defined benefit schemes are extremely high – when you are receiving a statement from your UK pension provider this is what is described as the cash equivalent transfer value. The reason for this is that gilt yields in the United Kingdom are the lowest that they have been in decades and the lower the gilt yields the higher the value of the pension. Why? Put as simply as possible the economics work a little bit like those of a mortgage – when the interest rates are lower you can borrow more because your monthly repayments can service a higher amount of debt. For more information read here.
As gilt rates in the UK will probably not drop any lower (in fact yields on inflation adjusted long term UK gilts are negative) the valuations are unlikely to increase. However, if in the future UK gilt rates go up the value of a member’s funds will drop significantly (despite the fact that their benefits will stay exactly the same – just like the fact that a person with a mortgage cannot effectively afford to borrow as much when interest rates increase.)
So if you do not transfer whilst the gilt values are low the value of your funds could fall significantly in the future as gilt yields potentially increase.
However, on the other side of this coin some company schemes have insufficient funds in them to support the level of cash equivalent transfer values required to be made when a pension transfer request is put in. This is because the low gilt rates have pushed up the value required to fund future pension obligations and most of the funds do not have sufficient investments to match the value required. Therefore, many of the schemes have committed to topping up the funding of these schemes. However, it must be remembered, as described above should UK gilt rates increase the value required to fund obligations will drop and the topping up requirements will lower. This is a complicated area to say the least.
A lot of people with final salary pensions, like the oil companies, banks and financial institutions and local council schemes and a host of others can have entirely unexpected pension values when it comes to transferring them.
We have seen plenty of instances where the cash equivalent transfer value (CETV) of a fund is greater than the amount of salary the individual earned while working at the organisation, and is a considerable multiple of the annual benefits promised. The reason for the high transfer values is the low interest rates in the UK. Essentially, it works the same way as a mortgage – for mortgages when interest rates are low the bank will lend more, well for final salary pensions, when interest rates are low the transfer values are higher. However, low interest rates will not last forever.
See some of the real life examples below:
Case study 1: Striking it rich with a Big Oil company CETV
The member of this scheme had worked for the oil company some thirty years ago, working their for around 12 years. When they left their final pensionable salary was just shy of £9,000, not bad for back then. Fast forward to 2013 and after taking into account inflation, really low interest rates in the UK and the fact that the pension scheme is fully funded and this members pension is worth over £200,000 as a CETV – that’s over 20 times what the final salary that the member left on.
Case study 2: Even a few years can be worth a lot (especially in banks)
You don’t have to be speeding toward retirement to find out that your retirement benefits have accrued significantly. Take this 47 year old member who worked for for a bank for just over 2 years. The scheme had told her that the annual pension at the date of her leaving employment (which had been 4 years before) was less than £1,400. Hardly enough to set the world on fire in terms of providing a retirement income into the future.
We helped her apply for a CETV and imagine her shock when the value of that came through at over £22,500. We helped her with the pension transfer and the rest is history.
Case Study 3: Local councils can be for profit when it comes to pensions
Local councils provide excellent work benefits. Take for example a council worker with 17 years of service in the UK who pretty much transferred on leaving the United Kingdom. With a pension benefit of £13,130 on leaving this individual was shocked to find that he had a transfer value of over £235,000 – which we promptly helped him to transfer to New Zealand.
New requirement for UK FCA advice for final salary transfers
The game changed on 6 April 2015 for people looking to transfer UK final salary pension schemes with a value of over £30,000 to a New Zealand QROPS. Now it is a requirement to receive advice from a Financial Conduct Authority (FCA) registered adviser. The FCA is the UK regulator for financial advice and in practice this adds an additional level of compliance to any final salary pension transfer. We are pleased to announce that our clients can receive advice from an FCA registered adviser as a part of our pension transfer service where that advice is required. To understand more about your final salary or defined benefits pension…get our free assessment of your UK pension