Don't fall for this pensions rip-off

Some employers are ripping off their staff by persuading them to give up valuable pension rights in return for cash. Make sure you're not ripped off too.

Pensions Minister, Steve Webb, is worried that some employers are ripping-off their staff when it comes to their pension rights.  I fear he’s right.

This is an issue that could affect anyone who is working and is a member of a final salary pension scheme – the best kind of pension to have. It seems that some employers are bullying their staff to switch out of final salary schemes and sign up for less attractive alternatives instead. This is sometimes known as incentivised transfer or enhanced transfer.

Fortunate

If you’re a member of a final salary scheme, you’re fortunate. When you retire, your employer will pay you a percentage of your salary as your pension, and that pension will probably rise in line with inflation until you die. The less attractive alternative is a defined contribution pension (DC) where your employer pays into a pension pot that will generate an income when you retire.

Final salary pensions are superior for several reasons:

-          The  pension is guaranteed by the employer.

-          There’s no investment risk. If the stock market fell by 30%, the value of most defined contribution pensions fall too. Such a fall makes no difference to the size of a final salary pension.

-          There’s no annuity risk. In other words, it doesn’t matter if annuity rates fall in the years before your retirement.

-          The pension is normally index-linked.

Sadly, final salary pensions are expensive for the employer, so I’m not surprised some firms are trying to persuade their staff to switch to a DC scheme.  If you switch, your employer will pay a sum of money into a DC pension pot and it might also offer an upfront cash incentive too.

Trouble is, the sums of money on offer are often too low. I’ll use one friend of mine as an example. He’s in his early 40s and used to work for a well-known UK company in his 20s. That company recently offered him £40,000 to give up a final salary pension that will pay him £6,000 a year when he comes to retire. (That’s £6,000 in today’s prices.)

My friend is fortunate enough to have some other pension provision, but if things went wrong with his other pensions, his £6000 final salary pension would be enough to live on. Especially when combined with a state pension. Why would he want to give up that security for £40,000?

Thankfully, my friend turned the offer down.

High pressure

In fairness, my chum wasn’t offered any upfront cash to spend now. And he wasn’t subjected to any high pressure sales techniques, unlike some people.

I’ve read reports of employees being told they had to say ‘yes’ or ‘no’ within a week;  employees being told they wouldn’t be allowed to retire early unless they switched to a DC pension; and people receiving offers in the run-up to Christmas when finances can be tight.

These techniques are despicable when you’re dealing with something as important as a pension.

Now I admit there are some situations where it might make sense to agree to a transfer but they won’t apply to most people. Let’s look at two circumstances when it might make sense to transfer:

-          Your health is poor, so you’d like to access as much of your money as you can before you die. If you transferred, you could take out a tax-free 25% lump sum from your pension pot in your late 50s.

-          If your employer is in serious trouble and the pension scheme has a large deficit. If the company goes belly up and the pension scheme becomes insolvent, the Pension Protection Fund will pay you a pension, up to a maximum of £29,897 a year. If you’re expecting a final salary pension that’s above that figure, it might make sense to transfer and receive a bigger income from a DC pension.

I guess there are two other reasons why a transfer might be the right thing to do. Firstly, you might be someone who places huge value on flexibility and the ability to manage your own pension. Transferring gives you that flexibility but, personally, I don’t think that the loss of income is a price worth paying for that flexibility.

Secondly, it’s possible that the transfer offer is much more generous than any I’ve heard of. However, it would make little sense for the employer to make such a generous offer, so this is a pretty unlikely scenario.

If you’re thinking about accepting a transfer offer, I’d urge you not to make the decision on your own. It’s essential that you take advice from a good Independent Financial Adviser. Make sure that you choose the adviser yourself – I wouldn’t trust any adviser that was provided by your employer.

And anyway, for most people, I’m still convinced that these transfers make little sense. Steve Webb is right to be concerned about this issue. He’s had a meeting with regulators this week and I hope he comes up with plans to tighten up regulation in this area.

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