Final salary v Direct Contribution Pensions

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Companies are higher paying golden goodbyes to get rid of final salary pensions than ever before.

Workers looking forward to a guaranteed £20,000 a year pension when they retire are routinely offered 30 times that amount to leave their workplace scheme.

That £600,000 in cash is tempting – but is it a good idea to ditch a guaranteed final salary pension for a riskier direct contribution pot?

The decision depends on each retirement saver and their financial circumstances.

Benefits of cashing out

Taking the extra cash means giving up guarantees but gaining more flexibility:

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  • Many final salary schemes have a set age for claiming pension benefits – this can be anywhere from 55 to 65 years old. A transfer out sets the age for withdrawing benefits at 55
  • The tax-free cash from a final salary scheme is typically less than the 25% paid by personal pensions due to quirky maths
  • Passing on unspent pension cash is easier out of a final salary scheme as inheritance tax rules let retirement savers pass the money on without tax if they pass away under 75 years old. Over 75, the heirs pay income tax on the money that goes to them
  • Moving out and cashing in is attractive if the retirement saver has a short life expectancy
  • If an employer looks like going out of business, transferring out can outweigh benefit cuts and the uncertainty of staying in the scheme – just look at the problems with British Home Stores and Tata Steel this year

Problems of cashing out

  • Leaving a final salary scheme means losing guaranteed benefits – not only retirement income, but cost-of-living rises and sometimes guaranteed annuity rates
  • Final salary pensions last for life, but personal pensions can run out
  • Final salary pensions are not linked to a rising or falling stock market that can impact on fund value
  • The employer carries all the risk of a final salary scheme, which is why so many are in the red. Cashing out shifts that risk to the retirement saver

What do the experts say?

City watchdog the Financial Conduct Authority (FCA) rules two years ago that transferring out of a final salary scheme should be considered unwise.

Since then, financial easing has altered the returns and with golden goodbye payments, in some cases, cashing in a final salary scheme can make a lot of sense.

Former pension minister Steve Webb, now with financial firm Royal London, is calling on the government to ease final salary scheme rules to allow retirement savers more control over their money.

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