Defined benefit pension transfer: is it worth it?
When it comes to saving for retirement, most people working within the private sector are likely to have a defined contribution (DC) pension. This essentially provides you with a savings pot you pay into throughout your working life; these savings grow over time through compound interest and tax relief and are, in most cases, only drawn upon once you retire.
However, those working in the public sector, such as the NHS, the police and state education, instead have a defined benefit (DB) pension which works under an altogether different system. Rather than a pension pot which is paid into by you, DB pensions depend upon three factors: your pensionable service, calculated through how long you have been a member of the pension scheme; your pensionable earnings, which is decided either through the salary you are earning at the point you retire, or the average salary you’ve earned during your membership; and the accrual rate of your scheme, which dictates the percentage of your salary you’ll receive per year of service.
In the past, the DB pension schemes of the public sector were envied by those in the private sector. However, the introduction of pension freedoms last year has seen something of a reversal of fortune for those with DB pensions. Pension freedoms have allowed those with DC pensions to withdraw lump sums from their savings pot but as those in a DB pension scheme don’t have a savings pot, they’re unable to do this.
It’s for this reason that some are now looking to transfer their DB pension to a DC pension scheme. For those in the public sector whose pensions come from taxpayers money and not a central fund (known as ‘unfunded’ schemes), this isn’t possible, for the simple reason that the money isn’t available to them until they retire. However, ‘funded’ DB pension schemes, such as local government pensions, are paid from a central fund and therefore can be transferred.
It’s worth noting that transferring from a DB to a DC pension scheme will likely leave you with less money in your pension savings, as the amount you will be able to move is dependent upon the transfer value of your DB pension. Some employers do offer transfer incentives such as enhanced transfer values or cash payments, however, which may make transferring more attractive.
The main benefit of transferring is the ability to take advantage of pension freedoms, so if you have plans for what you want to do with a lump sum then taking a hit on your monthly pension amount for potential benefits later on can be worthwhile. If you don’t have plans to take a lump sum, however, then remaining in your existing DB pension scheme may be the safer bet.
Any decision regarding your pension should be taken with financial advice; for more information, please feel free to get in touch with us directly.