Transferring a client out of a DB pension despite a lower income level
Transferring out of a defined benefits pension scheme might mean a lower level of income, but that can still be the best option, writes Rob Jackson chartered financial planner at Cheshire-based Jones Sheridan Financial Consulting
This case involved a recently retired 60-year-old divorced male client who wanted advice on how to draw benefits from his deferred final salary pension scheme.
A full review of his circumstances revealed that he was a balanced investor. He had an existing platform pension of around £60,000, from which tax-free cash had been taken, and an ISA on the same platform with around £5,000. He had no liabilities and a modest emergency fund.
I completed a detailed expenditure analysis, which showed that the client’s existing annuity of £12,250 per annum (with 6% annual fixed escalation) was insufficient to meet his annual income needs of £18,000 net.
The main objective was, therefore, to generate around £6,000 per annum of net income to bridge the period between now and age 66; from that age, the state pension and the existing annuity would fully satisfy his expected income needs.
The secondary objective was to maximise value from the existing pension funds for his adult children as he had no intention to remarry.
The final salary scheme pension was offering a pension of £4,400 per annum, plus a tax-free lump sum of £26,000. Alternatively, a cash equivalent transfer value of £139,500 was available.
The transfer value had been reduced by £35,000 because the scheme was 76% funded.
Our research centered on three key areas:
• Long-term need for secure pension income
• Short-term need for additional income
• Legacy planning for heirs
The transfer value showed that the critical yield for transfer into his existing platform pension, invested into a suitable risk-rated model portfolio, was 12.2%. Even when using the unreduced transfer value, which is our standard practice in such cases, the critical yield was relatively high at 7.1%. So we had to tell the client that he would receive a lower income from a transfer than the scheme.
However, we advised on a transfer for the following reasons:
• The scheme income was not sufficient to meet the client’s immediate income needs, requiring drawdown from the existing platform pension
• The tax-free cash from the transfer (£139,500 at 25% = £34,875) would be sufficient to meet his income shortfall for almost the entire six years to state pension age, even if held in cash, due to the high fixed escalation on the existing annuity
• After age 66, he would be paying tax on income from the scheme that he wouldn’t need and would die with him
• The entire value of the platform pension that he would not need to draw income from could be passed on to his children.
We used O&M Profiler to create a cashflow to visualise the two options for the client in our report. This made it easy for him to interpret an otherwise complex area of financial planning, and he accepted our recommendations.
First published in Zurich’s Advice Matters