10 Reasons Why Not to Move a Final Salary Pension Scheme to a QROPS
Most UK advisers heavily suggest against moving out of a UK final salary scheme due to all the safeguarded benefits it offers – normally a final salary scheme is linked to inflation (CPI index), it can provide a death benefit and there are some guarantees. However, on closer inspection, it may be worth looking into the possibilities to transfer offshore to increase both yield and returns, especially for sophisticated investors will larger pension pots looking for best outcomes with regards to inheritance planning.
What is a Final Salary Pension Scheme and Why Was it the Gold Standard for Pensions?
If you’ve saved into a final salary pension scheme, your savings have been invested into a mix of stocks, bonds and gilts during your working lifetime. You will receive tax relief both on contributions from your employer and tax relief on your own lifetime pension contributions.
The income you ultimately receive in retirement from your pension is a guaranteed, pre-agreed amount that will rise with inflation each year. It is these guarantees that are important in retirement.
Top Ten Reasons Not to Transfer from a Final Salary Scheme
- You would lose the link of your pension to inflation (CPI index)
- You would lose any safeguarded benefits including the Guaranteed Minimum Pension (GMP) from contracting out of the State Second Pension (S2P)
- You would lose the protection of the Pension Protection Fund (PPF) in the UK. This protects you 100% at retirement, but ONLY if your pension scheme becomes insolvent with payments capped at 2.5% per year.
- You would lose any guaranteed death benefits
- You cannot transfer back in at a later date
- You may lose any benefits tied to being able to retire early through ill health
- You would lose any guaranteed benefits paid to any spouses, partners or children upon death
- Defined benefit schemes generally pay larger pension incomes than defined contribution schemes
- A transfer out would expose you to the risks of investment management fund performance and stock market fluctuations
- You would lose a guaranteed income stream at retirement
Top Ten Reasons to Transfer from a Final Salary Scheme to a QROPS
Whilst a final salary pension scheme gives members a guaranteed income at retirement which is inflation linked, there are other reasons why those with large final salary pensions choose to transfer out to a QROPS including inheritance tax, estate planning, income tax, ability to control one’s own investments and currency risks.
Here are some of the benefits for British expats who want to transfer out of a DB scheme into a QROPS:
- Taking an early retirement – a QROPS allows retirement at 55, whilst some final salary schemes don’t allow you access until 60
- Taking a later retirement – as people live longer, your pension scheme will have to last for 30 – 40 years. That means taking your pension later in life will make your pension pot last longer with a higher annual income. Under a QROPS, you have total control of when to take your retirement benefits after 55
- Receiving a larger tax-free cash lump sum. A QROPS allows a 30% tax-free cash lump sum compared to only 25% under a final salary scheme. This may be useful if you want to buy property abroad for instance
- To Leave a Larger Inheritance. Most UK final salary pension schemes pass on only half to spouses at retirement and only in the form of income payments. A QROPS passes on 100% as a cash-free lump sum to any beneficiaries you name. This is helpful for divorcees; it is also particularly relevant for those with ill health or history of cancer in the family
- An employer may offer an incentive to transfer out of a final salary scheme. This may be in the form of an enhanced transfer value or even a lump sum. The employer may seek to do this to reduce the liabilities of their business. Many final salary schemes are not sustainable and almost all are closed to new business.
- Pension Payment Flexibility Options: a final scheme does not offer the same flexibility in terms of options as a personal pension scheme. For example, many QROPS allow full pension freedoms with flexi-access drawdown and 30% tax-free cash lump sums
- Investment Flexibility: you have total control over your investments in a QROPS. Under a UK final salary pension, everybody is lumped into the same investments
- Currency Choice: UK final salary schemes are paid out in GBP only; that can be a problem if you retire in the USA or Europe and currency exchanges start to fluctuate a lot
- Final Salary Schemes are Closing. The final salary scheme may be in danger of entering the Pension Protection Fund and the protected amount under the PPF is much lower than the current benefits. In which case, you may wish to transfer out and take a higher pension amount now
- Target Higher returns. Final salary schemes used to be linked to the Retail Price Index (RPI), a much higher measure of inflation; now it is linked to the Cost Price Index (CPI) which is currently exactly 0%. A transfer out even to a high deposit bank account may reap more benefits.