Life today is full of choice, whether you are looking to purchase a holiday, a car or a can of baked beans…. Heinz, own brand, value range, reduced sugar, snap pots and can size…. The same can be said for pensions following the introduction of the pension freedoms back in April 2015 (doesn’t time fly!).
So, is all this choice a good thing or a bad thing? Well, I guess you’ll be hard pressed to find anyone who can provide a convincing argument that lowering your sodium intake is a bad thing, but what about your pension?
First, we must look at choice, what purpose does it serve? As I see it, the very purpose of choice, its raison d’être, is to permit an answer, an outcome, or solution that matches a personal preference, achieves a stated objective or accommodates a constraint at an individual level.
In the context of pensions, the pros and cons of choice will differ based upon many factors. The most contentious of these is the thorny subject of individual transfers from Defined Benefit (DB) to Defined Contribution (DC) arrangements to gain access to the pension freedoms.
For members of DC schemes the introduction of pension freedoms is less controversial, as their pension savings are already in a format that marries to the wider choice of income at retirement i.e. annuities, cash lump sums and income drawdown. However, members of DB schemes must transfer their pension benefits to the (apparently) less salubrious DC format to take advantage of these flexibilities.
In most instances, DB schemes only afford individuals limited choice at retirement, for example the option to exchange part of their pension for a tax-free cash lump sum, but only on set terms that, ordinarily, are skewed in favour of the scheme. If an individual’s circumstances are such that the format of their DB pension benefits have little or no relevance to them, then the option to convert to a more flexible and pertinent basis must be viewed as a positive. Examples of increased choice and flexibility which can be obtained by a DB to DC transfer include, but are not limited to:
Death benefits – The provision of a dependant’s pension will be of little or no value to a member who is single, or who has a partner who is financially secure, yet this is accounted for in the calculation and ultimately the value placed upon the member’s DB benefit entitlement.
Post retirement longevity – with current actuarial estimates giving a post age 65 life expectancy of over 20 years for males and females, members in poor health may see greater value in converting their DB pension benefits as part of a considered inheritance tax planning exercise.
Scheme funding – concerns over a DB scheme’s funding level, the employer’s ability to resolve it and to provide adequate financial support over the longer term can be a major issue for some members.
Small pension accrual – the conversion of a small DB pension benefit, which would otherwise provide a negligible level of income in retirement, may be better used to pay off existing financial commitments.
Tax efficiencies – the ability to receive tax-free income, or to mix tax-free and taxable income elements from a DC arrangement is an attractive option. The rigidity of a DB pension benefit compromises this facet of individual wealth management.
The introduction of the pension freedoms affords us greater choice, and so long as decisions are made by individuals in an informed manner this can only be a good thing.
Phil Farrell