George Square Financial Management highlights some of the key differences in defined benefit and defined contribution private pensions and offers some expert guidance on whether pension transfers are always the right option.
Defined benefit pensions
Defined benefit (DB) pensions, or final salary pensions as they are often referred to as, have many advantages; they are sometimes considered to be the more generous workplace pension scheme. Generally speaking, your DB pension pays you a retirement income when you reach age 65. One of the major benefits is the promise of a secure annual income for life once you retire; this is based on your final or average salary.
In most cases, it is your employer who contributes to the plan (though sometimes the employee also contributes). The employer decides how to invest the retirement funds, though they must pay employees a fixed amount regardless of investment returns.
Defined contribution pensions
Defined contribution (DC) schemes are often considered to be the more flexible scheme of the two. From as early as age 55, you can access as much of your DC pension savings or pension pot as you like – even if you’re still working. Essentially, because you are the contributor rather than your employer, you have more control over how you receive your savings.
Depending on what type of DC scheme you have, you may be able to take either cash lump sums, a variable income through drawdown (known as ‘flexi-access drawdown), a guaranteed income under an annuity, or a combination of these options. But it’s important to remember that the earlier you choose to access your pension pot, the smaller your potential fund and income may be for later in life.
Because of their increased flexibility and the attractive transfer values being offered by pension trustees, DC pensions have become the pension of choice in recent years. Many people in final salary schemes are now opting for pension transfers. This means converting the benefits from their current scheme into a cash equivalent lump sum. This can then be invested into either:
- a personal or stakeholder pension
- a pension scheme with another employer
- a self-invested personal pension (SIPPs)
A few points to note are that not all pension schemes accept transfers and not every DB pension is transferrable. Some public-sector schemes such as the NHS pension are ‘unfunded’. They are supported directly by the taxpayer rather than by a central fund.
Legally, you need professional financial advice if you want to transfer from a DB pension that has a transfer value worth more than £30,000. The transfer can only be made once it has been signed off by a regulated financial adviser.
If you are considering a pension transfer, George Square Financial Management can guide you through the pension transfers process, helping you to understand the options available to you together with the costs and the risks, recommend suitable new schemes and manage pension transfers on your behalf. It isn’t generally considered best advice to transfer out of a defined benefit scheme. If we don’t think it’s your best option, we’ll inform you why you should leave your pension where it is.
Beware of transfer scams
Pension transfers have received some bad press recently due to the increasing number of scammers. If you are contacted unexpectedly from somebody claiming they can help you transfer your pension to get a cash lump sum or guaranteeing you higher returns than your current scheme, it is likely to be a pension scam. If in any doubt, get in contact with your pension provider for clarification.