Decisions regarding Defined Benefit pension transfers for expats should not be taken lightly. Such transfers are certainly not something that should ever be ‘sold’ or promoted as a ‘no-brainer’ by financial advisers. There are many details to understand and procedures to complete before committing to, and authorising, the transfer of what are often significant sums of money.
Having said that, Defined Benefit pension transfers into Defined Contribution plans can provide valuable financial planning opportunities in the right circumstances. For example, flexible access drawdown allows benefits to be taken earlier than in most Defined Benefit schemes. Many people use this facility to withdraw their 25% tax-free lump sum from the age of 55, and leave the remainder of their pension fund invested for use in later life.
Defined Benefit pension transfers for expats, in particular, have additional considerations which need to be thought through. These can swing the balance from a negative recommendation to one which is positive.
Occupational pension scheme transfers are complex and require the services of professional advisers who hold the necessary qualifications, knowledge and experience to ensure potential pitfalls are avoided and opportunities are maximised.
Defined Benefit pension transfers: Forewarned is forearmed
It is important for each individual to ensure that they are making the correct decision in light of their personal circumstances. Areas for consideration include:
1. Understand what you are giving up
Defined Benefit pensions contain valuable guarantees whereby income payments will always outlast us. Pensions are paid for life, are index-linked and offer death benefits for the spouse. These death benefits can take the form of a reduced income and/or lump-sum payments. In certain occasions, ill health and early retirement benefits may be available.
A properly written Appropriate Pension Transfer Analysis (APTA) report will outline all the pros and cons of transferring. APTA reports tend to be very comprehensive, sometimes to the extent that they can become unnecessarily forensic, creating confusion rather than clarity. It should also be noted that advisers are duty-bound to begin from the position that transferring out is usually not advisable.
2. Make sure the decision works in context with your overall financial planning
The consequences of giving up a guaranteed pension might be very different for one person, compared with another. A single person with no dependent children, for example, is much less likely to be attracted by the death benefits available under a Defined Benefit scheme than those associated with Defined Contribution schemes. Additionally, the Defined Benefit pension might not be the only source of income for an individual in retirement; he/she may have other assets which can be used for income generation.
In contrast, a Defined Benefit pension might be the only substantial source of income for someone else. Losing the guarantee or making an unfortunate investment decision could mean the difference between a comfortable retirement and a lifelong struggle.
3. Do the numbers!
If the decision to transfer is to be taken, it is necessary to understand the numbers involved.
Defined Benefit pension transfer values have never been higher; the pension multiple used to calculate equivalent benefits has also risen proportionately. We are all living increasingly lengthy lives; transfer values are supposed to reflect this. Consequently, multiples of 40x pension are not uncommon. When interest rates were higher and life expectancy lower, multiples were around 20x. This means that almost double the amount may now be on offer for the transfer of a pension.
The figures may sound attractive, however, the increased life expectancy comes with a price. Pension funds now have to last longer than before. It is, therefore, necessary to structure investments in such a way that they are sustainable for the whole of the rest of your life. As a ‘rule of thumb’, a withdrawal rate of 3-4% per annum should maintain, or even increase the value of the pension pot, if invested in an appropriate spread of funds. It is more important than ever to pay particular attention to the fund selection and regularly monitor performance.
4. Protect yourself from potential scams
One of the most disappointing aspects of pension transfer advice over recent years is the plague of investment scams which appear to be ever-present. Fraudsters are ready and waiting to relieve individuals of their hard-earned cash and regard pension pots as rich pickings.
Literally hundreds of millions of pounds have been scammed out of unfortunate pension-holders. The following checklist offers suggestions on how to avoid such scams:
- Not all cold calls result in scams, but all scams begin with an unsolicited approach from unscrupulous fraudsters. Put the phone down straight away! The caller won’t be offended and will simply move on to the next potential victim.
- Unless you are a highly experienced and ‘sophisticated investor’ you should be very wary of unregulated, alternative, esoteric investment ‘opportunities’. All investment frauds involve such funds/investments; very few are legitimate funds.
- Select daily traded, regulated investment funds provided by high-quality companies with a demonstrable track record.
- Check your adviser’s qualifications, knowledge and experience. This will give you the confidence you need to invest without losing sleep. Some of the most common scams are promoted by highly credible people; additional background checks are never a bad thing.
- Seek references and proof of track record.
- Be aware when you are ‘being sold to’. Anyone who tries to persuade you to act straight away, or risk losing the opportunity forever, is probably fibbing. Another opportunity will always present itself in time.
- Lastly, as the old saying goes, if it seems too good to be true, it probably is. This rule will never get old.
5. The taxation of Defined Benefit pension transfers
As Defined Benefit pension transfer values have become ever larger, so has the potential for the Lifetime Allowance (LTA) limit to be breached. The current LTA limit is £1,055,000; protection can, however, be sought up to £1,25m. If and when the value of a Defined Benefit or Defined Contribution pension exceeds this amount, the excess is taxable at rates from 25% to 55%. Solutions are available for expats by transferring into a QROPS plan. Once transferred the LTA can be avoided for life.
Brexit has created another potential issue whereby the Overseas Transfer Charge (OTC) might be applied to transfers from UK pensions to QROPS plans, just as they are for people residing outside the EEA at present. Assuming the UK leaves the EEA at the same time as the EU (Dec 31st 2020), the option of transferring to an overseas scheme is likely to be lost forever (or, until and if the UK re-joins).
6. Currency issues
Expat Defined Benefit pensions transfers have one potential disadvantage which can’t be overcome: the devaluation of Sterling. When the Euro was first introduced, the rate against the pound was 1.67. Five years ago it was circa 1.50; we are now at circa 1.17. Currency fluctuation should thus be an additional consideration when exploring the options of Defined Benefit pension transfers for expats. There is no risk for those who will live in the UK for the rest of their lives. However, for expatriates, any further drop in Sterling equates to a lower income in Euro terms.
No one knows which direction the pound will go post-Brexit. It may increase in value, which would be great for Sterling-based expats with Defined Benefit schemes. The key issue is to be aware of the situation and its impact on financial planning.
7. Advice costs.
APTA report fees have sky-rocketed recently due to an increase in Professional Indemnity Insurance premiums. Not that long ago a pension transfer analysis could be obtained for about £1,000. Fees now start at a minimum of £2,500 and can be as much as £15,000. Some advisers charge a percentage fee simply to write the report and effect the transfer, then charge additional fees to place investments.
Make sure you are fully aware of all costs and charges before agreeing to have a pension transfer analysis conducted!
Defined Benefit pension transfers: Conclusion
The list above is by no means exhaustive; it does, however, offer a basis for the decision-making process. It’s essential to work with a professional adviser who will create a plan specifically designed for your individual circumstances. Lifestyle issues can be just as important as hard facts and should be included in order for the advice to be both suitable and appropriate.