In our weekly series, readers can email in with any question about retirement and pension saving to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he doesn’t know about pensions. If you have a question for him, email us at money@inews.co.uk.
Question: I have two ‘defined contribution’ (DC) pension pots worth around £270,000. I am 62 and have just been made redundant. I’m living off my redundancy now and considering retiring and taking my pension from January. I have one “defined benefit” (DB) pension that’s been paying £180 per month since I turned 62. I also have a tiny DB pension of just £300 per year which will start paying me an income when I turn 65. Should I combine my two DC pots? Should I transfer my tiny DB pension into the DC pot? And should I use my tax-fee lump sum to pay off my mortgage that is due to finish its low fixed rate and use the rest to give me an income each month that’ll reduce once I get my state pension at age 67?
Answer: Before taking each of your questions in turn, the usual jargon-busting is needed. A defined contribution or “DC” pension is simply a pot of money that you can use to generate an income in retirement. Money held in a DC pot can grow tax-free and can be accessed flexibly from age 55, with this minimum access age due to rise to 57 in 2028. When you access your DC pension, you can take up to a quarter tax-free, with the rest taxed in the same way as income.
A defined benefit or “DB” pension, on the other hand, promises to pay you an income from a set age (your ‘normal retirement age’), based on the number of years you have been a member of the scheme and your salary. DB pensions also often offer a tax-free lump sum, often in return for taking a lower income in retirement.
If you have more than one DC pension, it can make sense to combine them with a single provider. This makes it easier to manage your pension and you could also benefit from greater investment choice, more flexibility and lower charges. It’s worth taking some time to research the market to make sure you choose a value-for-money provider that fits your needs.
Before transferring your DC pension, make sure you’ve double-checked there aren’t any valuable guarantees that will be lost or hefty exit penalties your existing provider might apply. These don’t tend to be an issue in modern pensions but were more common in older policies.
Should you transfer the DB pension?
With regards to your “tiny” DB pension, you will only be able to transfer this if it is from a “funded” scheme. This just means the scheme holds assets to pay out the pension promises made. Most public sector pension schemes, with the exception of local government schemes, are unfunded and so transfers out are not permitted.
If you have a funded DB pension, you can request a “transfer value” from your scheme – essentially the cash value of your former employer’s pension promise. If your DB pension is valued at £30,000 or less, you are free to transfer it to a DC scheme. If, however, it is worth more than £30,000, you will need to take regulated financial advice before transferring.
You should also carefully consider the fact you will be giving up a guaranteed, inflation-protected income for life in return for a DC pension that offers more flexibility and choice, but also requires you to take responsibility for managing your fund, including making sure your withdrawals are sustainable. As you are considering retiring relatively early, sustainability is generally something you should pay careful attention to.
Before taking your tax-free cash, you should have a plan for the money. If you leave it in your pension, it will have the opportunity to grow tax-free, meaning your entitlement could be boosted over time – albeit this is not guaranteed. Money held in a DC pension can also be passed on tax-efficiently to your beneficiaries when you die, and potentially completely tax-free if you die before age 75. If you die after age 75, any pension inherited by your beneficiaries will be taxed in the same way as income.
Should you pay off your mortgage?
In terms of the pure financials of paying off your mortgage versus investing, in simple terms paying off your mortgage is usually only worth considering if you think your investments will deliver a lower return than your interest rate. For example, if your mortgage interest rate is 4 per cent, your investments would need to deliver more than 4 per cent a year after charges. You should also check with your lender that there aren’t any charges associated with early repayment of your mortgage.
However, for lots of people paying off a mortgage is about more than just money, and you may prefer the certainty of knowing you are mortgage free as you enter retirement. Before making any decision, it’s worth consulting a regulated adviser to make sure you fully understand the options available.
