Over the past 12-18 months I have been contacted by many customers looking for advice and guidance in terms of their employer-sponsored final salary / defined benefit pension schemes.
Firstly, what is a Final Salary / Defined Benefit Pension Scheme?
A defined benefit (DB) pension scheme seeks to provide members with retirement benefits based on calculation methods set out in the rules of the scheme. The retirement benefits are usually based on:
- a member’s salary at their retirement age
- and their pensionable years of service.
The retirement benefits under a DB scheme are typically for:
- a lump sum of up to 1 ½ times final remuneration
- and for an annual pension payment of up to 2/3 final salary.
However, at a time when many businesses have decided that their defined benefit (DB) provisions are no longer affordable, continuing to provide this retirement benefit to ex-employees can be economically unrealistic. As most DB schemes are underfunded, these pension entitlements become highly dependent on the company’s capability to continue to support their x-employees DB retirement scheme benefits.
There are usually only a couple of options available to a business wanting to deal with this problem: one of them is a transfer value (TV). Currently in Ireland, many deferred members (x-employees) in DB schemes are being offered ‘enhanced’ transfer values if they leave their scheme. This can be an attractive offer to many x-employees, nevertheless it is important to recognise that there are many factors to be considered in making a decision whether to accept such an offer.
What is an Enhanced Transfer Value (‘ETV’)?
In short, the trustees who run the scheme convert the benefits you’ve built up in the scheme into a cash sum. This is called a ‘transfer value’ (TV).
However as mentioned, some employers are now offering their deferred members a further financial incentive to transfer out of their defined benefit pension scheme. In most cases, this incentive is an enhancement to the calculated transfer value of the benefits in the scheme, this is most commonly known as an ‘enhanced transfer value’ (ETV).
What happens if I accept the transfer value?
If you decide to take the transfer value on offer, you are transferring the responsibility of the management of your DB pension assets from the trustees of your DB scheme to a personal pension scheme chosen by you. You will need to receive detailed financial advice in this area to make sure the new personal scheme matches your requirements in terms of income, growth, risk and succession planning.
What are some of the reasons not to take the transfer value now?
- Confidence that the current DB scheme is well-funded and will pay out the promised annual DB pension in retirement
- A belief that a higher transfer value will be offered to you in the future
- You may require a defined level of income in retirement and will not accept the risks involved in choosing your own personal pension scheme.
Why might you consider taking the transfer value now?
- You might wish to access your pension benefits now, as you can potentially access your pension from age 50;
- You might hold the view that the solvency of the scheme may deteriorate even further, which could lead to a lower transfer value offer in the future;
- A fear that if you do stay in the DB scheme as a deferred member, that you might not receive the annual pension benefits you are promised once you come to retirement.
Should you speak to an advisor before making a decision?
I regularly meet clients looking to discuss the pro’s and con’s associated with the transfer offer from previous employers. We discuss and assess each client’s unique personal circumstances and financial position before they make any important decisions.
I have found that experienced pension advisors can assist clients by:
- comparing the benefits they may give up if they transfer out of their employer’s scheme -v- the benefits with those of staying within the DB scheme
- assessing the level to which their employer’s pension scheme is funded, the risk that their benefits may be reduced in the future and the effect on any transfer value offered
- discussing the advantages and disadvantages of their employer’s ETV
- assessing their additional sources of income, such as new employment income, property income, state pension, spouses pension, investment and dividend income
- assessing whether they have discussed the various options with their spouse / civil partner, as the decision will undoubtedly affect them too
- reviewing other issues and potential risks, such as: Is the scheme being wound up? Are there any deficit reduction plans by the trustees of the scheme? Is a Section 50 reduction in benefits being proposed?
Taking a transfer value offer from a DB scheme is an irreversible decision, so if you are approaching retirement, you should review all of your pension options before making such an important decision. You should initially seek advice with respect to your transfer value entitlements from the scheme Trustees and discuss your options with your Certified Financial Planner (CFP).
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Gerard O’Brien LL.B LL.M CFP® QFA is a Certified Financial Planner and the Owner of Heritage Wealth Management, a Financial Planning practice based in Main Street, Midleton, Cork. For more information, contact Gerard at email@example.com www.heritagewealth.ie
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