Following the introduction of UK Government policy reforms in 2015, Defined Benefit (DB) pension-holders from a broad range of industries, including those within the energy sector, are likely to find themselves with much more financial flexibility.
One of the key advantages for those fortunate enough to currently be in a DB scheme is that they have the option to transfer their existing pension pot into a Defined Contribution (DC) scheme where benefits can now be drawn down from age 55 (most DB schemes would penalise a pension-holder if they wanted to withdraw funds before retirement age).
For employees within the energy sector who hold DB pensions, this could be an astute time to consider moving their pot into a DC scheme. Currently high transfer values, which have come on the back of record low interest rates, could soon fall with market speculation now suggesting that interest rates are set to rise.
We are already seeing movement on this with inflation climbing to three per cent in September, up from 2.9 per cent in August. If, as is expected, it continues to rise it is likely to trigger an increase in interest rates and in gilt yields as investors demand higher yield to cover rising inflation. This upward movement will result in lower transfer values being offered for DB pensions because the scheme’s cost for providing the member’s pension is lower.
While the current forecast for interest rates to rise makes this the crucial time to consider a DB scheme transfer, it is, of course, important for every pension-holder to get independent advice, specific to their own circumstances.
For some, transferring may be the best option. We have seen a number of the energy sector clients we advise in Scotland benefitting from pursuing this route. In one case, a senior operations manager who has worked for a renewable energy company for 19 years, currently earning an annual salary of £82,000, was offered a cash equivalent value of £1,459,000 to transfer in September.
Another oil and gas sector client, an engineer on an annual salary of around £33,000 who had served just three and a half years with their employer, was offered £386,000 for transferring a modest DB pension to a DC scheme.
The transfer opportunity should also be considered by those who may no longer be working in the energy sector but still hold a pension from that period where they were employed within it. Many of these individuals who are now approaching retirement are finding their dormant pensions can often amount to a significant sum when transferred.
The pension-holder must, however, always consider the downsides before making a transfer as the risk shifts from the scheme to the individual. Unanticipated economic and political events can adversely impact on the value of DC pensions. This potential volatility must therefore always be factored into planning assumptions that are part of this process.
It’s also important to recognise that DB pensions are not always transferable. Where they are, the values are also dependent on the number of members in the scheme and their ages. The scheme funding position will also be taken into consideration when calculating the transfer value.
There is a potential opportunity available for DB pension holders to enhance their financial flexibility and secure a generous transfer valuation. With interest rate rises looking imminent, there may also be a limited window to get full benefit from doing so.
Under the Government’s new pension freedoms, the DC regime may prove to be a better solution for many individuals, especially those who want to get access to some of their funds before they retire. Getting good advice, however, is critical as there are pros and cons which every pension-holder must consider, depending on their situation and their personal retirement plans.
Kirsty Lister, Financial Planning Associate at Chiene + Tait Financial Planning
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