Types of Pension Schemes and Transferring Out
In this guide we explain what the pension act of 2015 means, what a defined benefit and defined contribution pension is, and why a transfer from a defined benefit pension is an increasingly attractive option for many.
The new pension freedom rules introduced by the UK government in 2015 has had a transformative effect on retirement income – particularly impacting annuities which were a low risk but potentially expensive option. Annuities prevented you taking control of your capital in return for consistent income certainty. However, for certain situations they are looking increasingly outmoded and less relevant for many.
The new pension freedoms act gives greater control and choice over your retirement money. This is good if you know what you are doing but it can also mean it’s easier to make mistakes and outlive your retirement funds.
The new freedoms only apply to defined contribution private pensions and not defined benefit or state pensions. You can access your private pensions at the age of 55 but it’s probably not a good idea to take it this early as you’re probably still working towards retirement and should be focusing on putting yourself in a position to have enough income when you do retire. Keeping the money in a pension hopefully enables it to grow.
In theory, at 55 you can choose to take it all in cash – but only 25% of it will be tax free. The rest is subject to tax at your current income tax rate. However, you can flex your income withdrawals to minimise tax.
If you live abroad or are planning to do so, another attractive option for many is transferring your pension pot to a recognised overseas scheme.
A defined benefit scheme is one where the amount you’re paid is based on how many years you have worked for your employer and the salary you’ve earned rather than depending directly on individual investment returns. Defined benefit pensions pay out a secure income for life which increases each year.
With a defined contribution pension, you build up a pot of money that you can then use to provide an income in retirement and depends on factors including the amount you pay in, the fund’s investment performance and the choices you make at retirement.
Company schemes have a set contribution for the employee and a set contribution for the employer. For example, in some DC schemes, the employer and the employee each contribute 5% of the member’s earnings, or 10% in total.
There was a long-held view that you should not transfer out of a defined benefit scheme as they provide a guaranteed income unlike a defined contribution scheme.
However, this may no longer be the case for the following reasons:
It should be noted that once the transfer has been completed it cannot be reversed.
They are available to ‘deferred members’ – those who have left the employer but have yet to draw their pension or cash sum and are also offered to employees on retirement or as part of an early retirement or redundancy package. With the introduction of pension freedoms many companies are now offering members transfers close to and beyond retirement age as long as no scheme benefits have been taken.
As a ‘deferred member’ a transfer option is your legal right with some exceptions such as some public sector schemes.
High Costs: different firms have different cost structures – they may charge for advice, trustee, administration, investment platform, withdrawals, the transfer cost itself and so on.
Get to the bottom of these costs – which are upfront and which are hidden, are there commissions paid to third party suppliers and how are they deducted from your fund.
It’s important for your adviser to be as transparent as possible and give you the real total cost per annum. If fees are in excess of 3% a year you should be aware that this may impact on your returns. Excessive ongoing costs are potentially more damaging to the long-term success of a transfer than a high initial fee.
Excessive Risk: protection is as important as growth so be careful where you invest your money. Be particularly aware of unregulated schemes – often these come in the guise of foreign property, overseas resort developments, timber, biotech and car parks.
These schemes are often very risky, collapse or are sometimes even scams and they operate beyond the reach of the regulator. It’s easy to lose some or all of your money so we recommend you stay well clear.
Pension Life Time Allowance: If the value of your pension(s) are close to £1,055,000, or likely to reach this by the time you retire, you need to be aware of the lifetime allowance.
The lifetime allowance is a limit set by the government on the total amount you can build up in pension benefits over your lifetime while still enjoying the full tax benefits. If you go over the allowance you will pay tax on the excess* when you:
*unless you have some form of Primary, Fixed or Individual protection.
Any excess over £1,055,000 may be subject to a tax charge of 55% of any lump sum and 25% of any income. This charge applies to all types of personal pensions but not state pensions.
The first step is to request a pension transfer valuation in writing from your scheme – any reputable pension advice company can help you with this by submitting a ‘letter of authority’. Ensure you get advice from a suitably qualified adviser and the firm has the right licences – such as those issued by the Financial Conduct Authority (FCA).
A Transfer Value Comparator (TVC) report will likely be required before your pension is allowed to be transferred which means sharing your personal data, plans and financial objectives with your adviser.
Once this report is completed and you know what your options are, you can talk with your adviser, discuss the TVC and weigh up whether a transfer is right for you. Take into account such things as the tax treatment of the personal pension fund created by the transfer and an explanation of the risks associated with the transfer option versus remaining in the scheme.
Also, if your transfer value is high – over a £1million for example – how does the lifetime allowance (LTA) impact your funds?
And finally – what does the future investment strategy look like and what are the associated costs of managing the pension scheme – both of which can have a significant impact on your fund’s performance.
We recommend you seek qualified, professional advice prior to transferring out and investing. If, after reading this document, you have any questions or would like any additional information please contact us and we will get one of our advisers to speak with you.
Brite Advisors re-defined UK pensions for expats when they launched in 2016. Today, Brite Advisors leads the world in UK pension innovation with our low-cost investment platform and end to end solution. The Brite Advisors platform provides a seamless experience with the mission of maximising pension assets. Brite Advisors is a global company with offices and teams around the world dedicated to providing a financial planning experience like no other. For international SIPPs, QROPS or Direct Investing it’s your easiest investment decision.
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