BY JOHN ELLIS, FINANCIAL ADVISOR
In 1982 The Clash asked the age-old question: “You got to let me know should I stay, or should I go now?” The self-same question is being asked by clients in defined benefit schemes (DB) – should I stay in the scheme, or should I go?
A DB pension is a rarity. It is an occupational pension scheme that promises to provide a set level of pension at retirement, the amount of which normally depends on your service and your earnings at retirement or in the years immediately preceding retirement.
Depending on the scheme, it may have very valuable underlying guarantees and deciding whether to stay in the scheme or take a transfer value requires careful consideration of the various factors and risks involved.
The first consideration is, should you stay put in the scheme. There are risks associated with leaving the benefit in the scheme, which may result in you not receiving the full pension promised.
Normally, by staying put, your pension will undergo annual adjustments until you retire called your normal retirement age (NRA). These adjustments are typically the lesser of 4% a year and the Consumer Price Index (CPI), which could be negative or positive.
With inflation running higher than 4% a fear your pension should see the full 4% increase applied. This is okay for solvent schemes, but insolvent schemes may be put under pressure causing employers to consider the long-term financial commitment and their capability to fully fund the scheme.
Some have applied to reduce benefits for active and deferred members instead of winding up the scheme or have reduced the pension in payment for those in receipt of a pension (if not secured by an annuity) through a Section 50 order.
As has happened in the past, due to market conditions and bad investment decisions, trustees have applied to wind up a scheme altogether and have the assets distributed to all members in a prescribed way. After winding up expenses the assets are distributed according to a particular set of rules. (This article doesn’t allow the space to outline the rules fully, but I would be happy to send you the details.)
Suffice to say that those who have yet to take their pension and those still active, ie. contributing to the scheme, are particularly exposed in a wind up because if there are not enough assets to go around their transfer value can be less that the standard transfer value.
In one sense then, a deferred pension is a form of IOU, a piece of paper backed by current scheme assets with anticipated future employer contributions and investment growth, promising a future benefit.
One way to check the health of your defined benefit pension scheme is to look for a transfer value. This is a lump sum payment in lieu of your deferred pension. Basically, you forego the proposed annual pension for a once-off payment. This is typically calculated in line with Pensions Authority Guidance.
In the past clients who have asked for transfer values have commented that the lumpsum offered is “very small” in comparison to the pension promised at retirement date. But you must remember that the actual amount offered (TV) broadly represents the value you would actually receive from the scheme if it wound up today.
In effect, the transfer value figure is the only asset currently backing your promised pension with the rest coming from future contributions and investment growth, which may or may not happen.
According to Standard Life, “the transfer value is therefore often the canary in the coalmine. A very low transfer value compared to the alternative deferred pension tells you there’s probably a hole in the scheme funding”.
Ultimately the decision is yours and next time we will look at your options in more depth but remember whatever decision you make it should align with your financial goals, risk tolerance, and long-term retirement objectives.
T: 086 8362622