For a retiree the decision of whether or not to switch from a DB to a DC pension scheme is very much dependent upon individual circumstances.
Doncaster, South Yorkshire (PRWEB UK) 6 August 2014
Following the Budget reforms, which have granted savers unrestricted access to their retirement pots, those with defined benefit pension schemes are left with the difficult decision of whether to stick with their generous final salary pension or twist and switch to a defined contribution scheme. Could such a gamble pay off though?
Defined Benefit (DB) schemes, commonly known as final salary pensions, pay an income that is linked to an individual’s earnings from employment and are usually defined as a percentage of their last year’s salary or an average of their income over their employment.
Defined Contribution (DC) pensions, on the other hand, are either taken out privately or through work. These schemes build-up a pension pot from which the retiree buys an income for life through an investment called an annuity.
There are many advantages of DB pensions – These schemes offer a guaranteed income as well as high levels of death benefits for the retiree’s spouse or civil partner. They are also escalated in retirement to keep pace with inflation so that living standards can be maintained well into later life. So why would people want to switch from a final salary pension into a DC scheme?
Well not everyone is married or needs to provide for a partner for a start. For single people or those with partners with independent means it can sometimes be an unnecessary built in benefit and they could take the view that they want more income for themselves in retirement.
Also if you’re ill and have a shortened life expectancy, then the guaranteed, generous but inflexible income of a final salary pension is not as crucial as it is for people who want their index-linked pension to still be paying out 30 years later.
It’s this lack of flexibility that is the main drawback of a DB scheme. The income usually starts low in early retirement and escalates each year meaning the most income is always in later life, probably when it’s needed the least. Making the most of early retirement with nice holidays, new cars and meals out is attractive notion to most people, as this is when they feel they are fit and healthy enough to appreciate it.
This is where one of the main advantages of a DC scheme comes into play. As of next April, anyone with a DC pension pot will see restrictions on how they access their money lifted. This will mean that they will be able to dip into their pension as they see fit subject to tax at marginal rates.
Scott Mullen director at My Pension Expert said;
“For a retiree the decision of whether or not to switch from a DB to a DC pension scheme is very much dependent upon individual circumstances. For some, a DB scheme will fit perfectly with their retirement needs, however there will equally be people that could benefit from the new pension freedoms and therefore should seriously consider DC.
“Deciding between the two schemes will no doubt cause some serious dilemmas and it has prompted the government to insist that anyone wanting to give up their DB scheme take professional financial advice, which is essential given the gravitas of the decision.”