Hundreds of thousands of savers with ‘final-salary’ pensions, are already trading in their future guaranteed income for a large cash lump sum. It is estimated that as many as 10% of the 3.7 million private sector workers who are yet to start drawing their final-salary pensions will cash out, enabling them to take advantage of the flexibilities associated with ‘defined contribution’ pensions.
In recent years these generous pensions, which pay a guaranteed income linked to the workers’ wage at retirement have become a dying breed. The huge attraction of final-salary schemes have been significantly outweighed by the new freedoms, enforced by the government in April 2015. In order to benefit, final-salary members have to transfer their accrued benefits out of their final-salary scheme. There are many reasons why it makes good sense to do so.
The important question is: how much income you could get after tax compared with the pension you’re giving up? The new flexibilities make tax planning more efficient, limiting you higher-rate tax bill in any single year – crucial for those with significant income from other investments.
The amount your final-salary scheme offers you in exchange for your pension is important. The calculations are usually based on the average member’s lifestyle, so for those in poor health and unlikely to live as long the value will be significant. The new scheme will also be attractive for single people, since calculations tend to include any pension that would be paid to a spouse after your death.
In reality, some people will simply like the flexibility, regardless of the terms. A lump sum early in retirement may be very attractive for some savers, perhaps to clear a mortgage, pay for a holiday or even to re-invest. The same applies for those who are worried about their health – perhaps a modest top-up in early retirement, followed by a larger sum later on may suit. The fact is the new flexibilities give you much more scope to plan your retirement based, without being tied into a scheme with little room for manoeuvre.
And for those keen to boost their income further, investing their lump sum into an ‘income drawdown’ is a great option. This type of pension allow retirees to carry on investing their pension while taking a flexible income from it – providing the potential for enhanced returns.