Why Should You Consider Transferring Your Defined Contribution Pension?

The main reasons for transferring a money purchase or defined contribution pension are as follows:

  • Drawdown Options
  • Currency
  • Investment Selection

Other reasons can include:

  • Receiving advice throughout retirement
  • Consolidation of all pension ports

Drawdown Options – Comparison

When pension freedom came into play in April 2015, it meant that people in defined contribution schemes didn’t have to buy annuities anymore. An annuity provides you with a guaranteed income for the rest of your life. You hand over your pension as a lump sum to an insurance company, and they calculate your annuity based on age, whether you are male or female, the size of your pension, where you live, and the state of your health.

Types of Annuities

  • Level annuities – It gives you a flat income per year which doesn’t go up with inflation. This is the most common.
  • Inflation-linked annuities (RPI) – The income rises in line with RPI just like a DB might do. These will come at a reduced rate than the level annuities.
  • Investment-linked annuities – These track the stock market to secure a better income year-on-year and are very rare.

Once you buy one of these 3 types of annuities above, they cannot be surrendered or exchanged into cash. Current annuity rates are at a record low, and they have halved in the last 10 years. Therefore, almost no one takes this option, as if you took a joint-life 50% annuity, 3% escalation annuity with no guarantee at 55, you would have to live for over 50 years until you’ve spent more than what you originally invested. Less than 2% of the UK population take an annuity each year, and most of the people that did are the ones who were automatically enrolled into one at the age of 75 as they haven’t done anything with their pension. Some DC schemes still don’t give you the flexi-access drawdown option, so unless you want to buy an annuity, you will need to transfer into a SIPP. Most providers though are updating their pension plans as they’ve been losing loads of business by people transferring away.

Within a SIPP or QROPS, you are not forced to buy an annuity, however, if the rates become as favourable as they were in the 90s and the interest rates were high again (although highly doubtful), then you could buy an annuity through your SIPP/QROPS. This is great as it opens the door to all options, as opposed to just buying an annuity and taking the exchange rate at the time of retirement. If you take the flexi-access drawdown option, 100% can be passed onto any beneficiary.

Currency – Comparison

This point is exactly the same for DC schemes as with DB schemes with a couple of slight alternatives. The currency rates will remain the same but the fund selection within a lot of DC schemes is restricted usually to only UK funds which mainly have large UK equity weightings. A few negatives on this are that if the UK market is performing bad, then there are fewer alternatives, and if they are retiring outside of the UK, then it’s invested in the wrong currency.

Not only does a SIPP/QROPS allow you to change the currency, but it also allows you to invest in different currency funds. This can have a huge advantage, and if someone is retiring outside of the UK it’s a no brainer.

Investment Selection – Comparison

Investment selection is almost always limited. Generally speaking, the client’s money will be pooled together into a selection of 5-20 funds based on their attitude to risk. These are usually a mix of active and passive funds that are tied to the pension provider, but not always.

When you originally set up your UK DC pension schemes, it was usually at the beginning of your employment, therefore you would have ticked a box for your attitude to risk, and probably left it the same ever since. So, if you have had the pension for 15 years, your attitude to risk has probably changed, yet you will still be in the funds from what you originally selected.

One downside to these funds is they might all perform below the benchmark average, so what we can do after we obtain the relevant information back from your pension scheme is give you a comparison between your fund performance vs ours.

Another common attribute to defined contribution schemes is an investment strategy called life-styling. This is where your funds disinvest the older you get so that by retirement age, it ends up sitting in cash to buy an annuity. Although this strategy does make sense, it happens automatically, and it could be timed extremely wrong. Having an adviser who reviews your portfolio annually means that it’s timed better based on a market view, not by your age. There are times where we have reviewed DC pension statements and clients have been invested into cash for years due to life styling funds.

We can invest in thousands of different funds globally, in all major currencies, but we stick to using passive funds which cost in total around 0.25% annually, and the performance has consistently outperformed almost all funds in the world, in all asset classes. Due to the cost, it’s very rare that we can’t decrease the overall cost of people’s pensions and get better performance.

This communication is for informational purposes only based on our understanding of current legislation and practices which are subject to change and are not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.

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