Due to the complexity of the legislation and scheme rules surrounding occupational pension contracts, it is not always obvious what the value of a pension plan is. Before transferring a pension it is important to fully appreciate the value that is being given up and whether this is important or not.
Some occupational schemes, if started before 2006 and particularly before 1989, may allow more than 25% of the fund to be taken as tax-free cash. This applies in particular to executive pensions and self administered pension schemes. Under the old legislation the tax-free cash amount was dependent on an individual’s pensionable salary and length of service and could entitle the owner to as much as 100% of the fund paid out as a cash lump sum. If such a plan is transferred this extra cash is lost and would fall to 25% of the fund.
Schemes known as section 32 buyout plans can also offer more than 25% of the fund as a tax-free cash lump sum. These plans also contain a ‘GMP element’. This stands for guaranteed minimum pension. This is the minimum amount of annual pension which the scheme has to pay the member, regardless of the value of the fund size.
This means that a small fund value can often be worth a much bigger pension than it would be possible to buy on the open market. The GMP shown on the pension statement may however simply be the value at the date of leaving. This may be a small amount but GMP has to be increased each year until retirement. This can be by a significant amount so that a small pension can be many times greater once the increases are added in. For example, a pension of £1,000 pa at the date of leaving, revalued at 7% pa for 20 years, becomes a pension of £3,869 pa today.
Increases in occupational pensions between leaving the scheme and drawing the pension is a feature which is also not always clearly stated on occupational pension statements. If you were in a final salary scheme for more than 2 years (5 years prior to 1986), you have an entitlement to a ‘frozen pension’. However the term ‘frozen’ is misleading as rather than being a fixed amount on the day you left, the pension is required by law to increase each year by a factor linked to inflation.
Schemes do not always make this clear in their statements and so it is important to get the up-to-date, revalued pension figure before deciding to transfer.
A pension may also include a spouse pension for a married member or partner and increases in the pension each year, once in payment. These additional benefits could cost thousands more than the fund value could buy in the open market.
Some older personal pensions and retirement annuities available in the 60s, 70s and 80s also offer guarantees such as a guaranteed annuity rate which can be applied to the fund at a given age when converting the fund to a lifetime income. These terms were offered at a time when interest rates were much higher than they are today but are fixed contractual terms which may produce a far greater lifetime income than could be bought with the fund value.
Some guaranteed annuities are only available on a single life basis, so no provision can be made for a surviving dependent. Others do allow a joint annuity basis and in some cases the policy owner can trade part of the guaranteed rate to include a pension for a surviving dependent.
Some with profit pension plans offer additional benefits by way of guaranteed bonuses or guaranteed fund values. Often these are only available at a specific age – usually the original retirement age of the plan. This can mean a large uplift in the value at that age and so it could be worth waiting until then before accessing or transferring the pension.
This is also often the time when any contractual penalties for early access or transferring away, which apply to a few older plans, cease to apply.
A consultation with an independent financial adviser may be necessary to uncover some of these hidden gems and to avoid losing valuable benefits. A decision to transfer your pension or not can only be made following a full assessment of their worth to you which will of course depend on your personal circumstances.