There are currently many adverts on TV, radio and online encouraging you to transfer your pension to a new provider, and there are benefits in doing so. However, deciding to transfer a defined contribution (DC) pension requires a careful evaluation of potential impacts before making a decision you may later regret.
Before providing the five most important things to consider before you transfer a pension, it is worth explaining what I mean by a Defined Contribution (DC) pension. A DC pension is also referred to as a ‘Money Purchase’ pension and includes pensions provided by your employer. Contributions are made by you, and if part of a workplace pension, by your employer too, into a pot in your name. Your contributions, if made after you have paid tax, receive basic rate tax relief automatically. The contributions are invested in the global investment markets, which grow over time until you decide to access the pot at retirement. Then you have different options to provide an income.
Having provided the context, here are five considerations before making such a significant move:
1. The Impact of Charges:
Before proceeding with a pension transfer, it’s crucial to fully understand the charges involved. It may come as a surprise to some, but there will be fees paid on the pension, which should be (but aren’t always) clearly disclosed. If they aren’t the pension provider isn’t being as transparent as they are required to be.
Fees include possible exit charges from your current pension, as well as initial costs and advice fees for the new one. If you are using a direct-to-consumer pension provider there won’t be advice fees but there may be initial charges to consider.
You should also compare the annual charges that you were paying to the ones that you will pay for the new pension; your existing pension may have lower charges, particularly if you are part of a large company that may have negotiated better terms with the pension provider. The new pension will have to grow considerably faster to make up for higher costs, which may mean more investment risk.
Importantly, the more you pay in charges the less you will have available to you in retirement to provide an income.
2. Variability in Investment Performance:
The desire for superior investment performance can be a double-edged sword. While the potential for higher returns is appealing, it’s important to remember that investment markets are unpredictable. Past trends don’t determine future performance, and higher returns require greater risk. With DC pensions you decide how you invest but many pension providers offer ‘off the shelf’ solutions to aid your decision; ensure that the investment strategy of the new pension aligns with your risk tolerance and retirement goals.
A common misconception is to compare the performance of two existing pensions and conclude that company A is better than company B because it has performed better. It’s not as simple as this; valid reasons, including investment strategies, will explain the different returns. You can find more information about that here.. You can read more about that here.
3. Loss of Guaranteed Benefits:
Some DC schemes, especially older ones, may include guaranteed benefits such as a guaranteed annuity rate which can be significantly more favourable than current market rates. These guarantees are a valuable feature, offering a higher level of income security in retirement than you might obtain elsewhere.
You might have invested in an old With-Profits fund; while it could be unsuitable for many, a guaranteed growth rate for the fund might meet your needs. Check if this applies to you.
Transferring away from a scheme could mean losing these valuable benefits, which could be detrimental to your retirement income.
4. Access to Pension Funds and Flexibility:
The ability to access your pension in a way that suits your retirement plans is an important consideration. Pension freedoms rules have provided greater flexibility over how you access the pension in retirement, but not all schemes offer the same options. If accessing your funds flexibly is important to you, ensure the new scheme provides this ability to manage your retirement income effectively. Modern pension contracts should offer the full range of options, but check if you’re uncertain.
The same principle applies to the treatment of your pension upon death; your beneficiaries will prefer to choose how and when they receive the benefits. Modern contracts should offer more options, but it’s important to check before making any transfers.
5. Loss of Enhanced Tax-Free Lump Sum:
As a standard rule, from age 55 (rising to 57 in 2028), you can take 25% of the value of the pension as a tax-free lump sum. However, some older pension schemes may offer the right to take a larger tax-free lump sum. Transferring to a new scheme could mean forfeiting this enhanced entitlement, potentially creating a greater income tax liability when you access the pension.
Transferring a DC pension has implications for your financial security in retirement. Often it will be of benefit to you, but before committing find out what you are giving up so you don’t make a decision you later regret. This includes not just the immediate financial implications, but also the long-term effects on your retirement income and flexibility. As such, it’s advisable to approach this decision with a comprehensive understanding of your current and future needs.
Most financial planners and advisers will give you independent and fair advice on whether you transfer a pension based on your unique situation and needs. Naturally, fees will apply, but you might discover that the cost of advice is lower than the cost of making a mistake on your own. If you feel you could benefit from advice you can contact me to arrange an initial meeting.
