Should I accept pension transfer value?
Your questions answered
Query: I left my former employer two years ago after working there for almost 20 years. I have an entitlement to a pension from that company's defined benefit (DB) pension scheme. I have received a letter from my former employer, offering me an 'enhanced transfer value'. Should I transfer my benefit entitlement out of that DB scheme. I have a defined contribution (DC) scheme with my current employer. What do I need to bear in mind when coming to a decision? John, Carrick-on-Shannon, Co Leitrim
Answer: There has been a big decline in the number of defined benefit (DB) pension schemes in recent years. For many schemes, a combination of increased longevity, low interest rates and changes in accounting rules have resulted in scheme liabilities outweighing assets - a funding deficit, and an increasing cost burden on sponsoring employers.
Many schemes are either closing to new entrants, closing to future benefit accruals or winding up altogether. An added problem for employers and trustees is that for many DB schemes, deferred members outnumber current active members. (Deferred members are former employees who still have a benefit entitlement in the scheme and have not yet retired.)
In an attempt to ease the administrative and financial headache associated with these scheme members, many trustees and employers have contacted former employees and reminded them of the option they have to transfer out to alternative pension arrangements. Sometimes a financial incentive to do so is offered.
There are a number of things to consider when deciding whether or not to transfer out of your DB scheme.
The first and most important factor to understand is that if you transfer out of the DB scheme of your previous employer, you will be transferring your DB benefit into a DC arrangement - either the DC scheme you have with your existing employer, or a buyout bond which you take out yourself. If transferring to a DC scheme, the investment risk in relation to the pension fund passes from your former employer to you personally.
On first impressions, a DB pension scheme is the best type of pension you can have - they're often referred to as 'Rolls-Royce' pensions. A DB pension promises to pay you a pension based on a percentage of your final salary so planning for the future is easy. However, the ability of a DB scheme to pay you a pension based on your final salary depends on the scheme's ability to fund its pension obligations for all members going forward. Benefits under DB schemes are not guaranteed. If a scheme's assets are not sufficient to pay the benefits (liabilities) and the employer is not in a position to meet the shortfall, the pension promised to you may have to be reduced.
Therefore the current funding position of the scheme is an important consideration if you are offered a transfer value. If the scheme is not fully funded, this will be reflected in the transfer value provided to you.
That's not to say that if a scheme is currently in deficit, it will remain so - or that an employer company will not be in a position to eliminate the deficit going forward. The opposite is also true. A currently fully funded scheme may not remain so. Consideration therefore needs to be given to the financial health of the scheme, and the future financial health of your former employer - in so far as this can be determined.
Some DB schemes offer enhanced transfer values - where you typically get a better transfer value than a shortfall in a DB scheme would typically allow for - to try to encourage existing members to leave the scheme.
If taking any transfer value to a DC arrangement, you would need to calculate the investment growth which you would need on that transfer value to provide you with the same - or a higher level of benefits - than the DB scheme was promising to pay. The required level of investment growth (which you would need to give you equal or higher benefits than the DB scheme) may well be accompanied by a level of investment risk which you are uncomfortable with. For this reason, many deferred members of DB schemes have in the past decided to remain in the scheme.
However, the financial pressures which many of the employers who provide DB schemes are under have made people reconsider.
Deciding on whether to take a transfer value from a DB pension scheme is an important decision and it cannot be reversed. It is important that all of the options available are reviewed and considered carefully.
If you stay in the DB scheme, the current financial health of the scheme may well improve or diminish over time.
Transferring out may well give you greater flexibility in terms of when and how to access your benefits, what the pension invests in, how much income to take in retirement (you would no longer be limited to a specific amount each year) and so on.
There are risks involved in staying in the DB scheme - or in taking the transfer value. However an enhanced transfer value does reduce the risks of taking a transfer value somewhat. Get independent financial advice before making your final decision.
DC v DB retirement options
Query: I have an old defined benefit (DB) pension scheme from a previous job - and a defined contribution (DC) pension scheme with my existing employer. I have about five years to go until I retire. Is it true that I have better options at retirement with my DC scheme than my DB scheme? I have heard that I am restricted with what I can do with my DB pension when I come to retire. Imelda, Dun Laoghaire, Co Dublin
Answer: Defined benefit (DB) schemes only offer the option of an annual pension and/or a lump sum at retirement. Lump sums are calculated by a formula relating to final salary and service - with a maximum lump sum payable of one-and-a-half times final salary.
All defined contribution (DC) pension arrangements (including Personal Retirement Bonds) now have access to an additional set of options. In addition to the option of an annual pension, DC pensions can pay lump sums of 25pc of the accumulated fund at retirement, and invest the remainder in an Approved (Minimum) Retirement Fund - A(M)RF - post-retirement. An A(M)RF is a personal asset which provides greater flexibility in terms of how income is accessed post retirement, when compared to the traditional DB annual pension. However, there is a risk that you could outlive your A(M)RF if you draw funds out too quickly. This is not a risk you need to worry about if getting an annual pension from your DB scheme.
If you die before your A(M)RF is spent though, it can be passed on as part of your will. DB pensions usually have spouses or dependants pensions included. This means that in the event of your death while in receipt of a DB pension, if you had a spouse or a dependant still alive, some of your pension would continue in payment to them after your death. If your spouse pre-deceases you or you no longer have dependants, then the DB pension effectively dies with you.
So in short, the advantages which a DC scheme might have over a DB scheme include the potential for greater lump sums, flexibility in terms of access to income, and flexibility for succession planning.
- Alan Casey is a pensions specialist with Bank of Ireland Investment Markets
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