Sunday 21 January 2018

Defined benefit: what if your pension plan runs out of money before you retire?

JOHN is 64 years old and due to retire at 65. He is currently earning €40,000 a year and is a member of a defined benefit pension scheme.

When he first joined the scheme, he was told he would get a pension equivalent to one-60th of his salary for each year of service. John will have worked for 30 years by the time he retires, so he therefore expects to get a pension of €20,000 a year -- and a widow's pension of €10,000 a year for his wife should he die before her.

Over the past few years, the company pension scheme has run into funding problems. About a year before John is due to retire, his employer decides to wind up the scheme and John finds out there is only enough money left to secure about 60 per cent of his expected pension.

What kind of a pension will John get now?

John's pension could now work out at only €9,580 a year for the rest of his life -- while the widow's pension for his wife could fall to €4,780 a year, according to Peter Griffin, director of pension firm Allied Pension Trustees.

"Let's assume that after the scheme is wound up, John is told that his share of the company pension fund is €170,269," said Griffin.

"His only option at this point in time is to invest the €170,269 conservatively and use it to secure a pension when he turns 65.

"At the age of 65, let's say his pension fund has grown from €170,269 to €173,365. This fund could buy John an annual pension of €9,580 for the rest of his life -- and a widow's pension of €4,780 for his wife. This is less than half of the €20,000 pension that John was expecting."

In the case above, John has not taken a tax-free lump sum on retirement -- if he did, his annual pension would work out a lot smaller. John may also be entitled to the State pension, which is currently up to €230.30 a week -- or about €12,000 a year.

What pension would John get if he retired at 70 instead of 65?

Allied Pension Trustees calculated how much of a pension John would get if he retired at 70. Let's assume that John's salary increases by 2 per cent a year after the age of 65, bringing his final salary to €44,100. If the pension scheme is fully funded, John can expect a pension of €25,725 if he retires at 70, compared to €20,000 if he retired at 65.

However, if the scheme is wound up with a shortfall of 40 per cent, he'll only be entitled to 60 per cent of the pension he expected.

John therefore may only get a pension of €12,093 a year if he retires at 70, according to Griffin. This is still more than the €9,580 annual pension he would have got had he retired at 65 when the scheme was underfunded.

Sunday Independent

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