There are upsides and down to taking a pension transfer offer
Over the past 12 months, I’ve been contacted by a large number of people, looking for help and advice in relation to a defined benefit type pension they have or had with an employer of theirs.
The reason they reached out for help is because they have been offered an enhanced transfer value (ETV) in exchange for the pension their employer promised to pay them when they reach retirement age.
And they want to know should they accept or decline the offer?
The reason companies are offering ETVs is Defined Benefit pensions have become too expensive and economically unviable to continue.
There are risks to taking an ETV and risks in staying in the DB scheme, you just have to be aware of what they are. Once you know and compare the advantages and disadvantages of each, you can make a more informed decision about which is best for you.
DB scheme advantages:
1. You have a fixed income for life, with no need to worry about investing the ETV amount and no need to worry about how markets perform in future.
2. The value of the DB payable is much greater than the ETV offer.
3. Your preserved benefit may increase in line with inflation/CPI index.
There are, however, potential disadvantages should you remain in a DB scheme as well.
1. If you remain in a DB scheme, it could be wound up and you may not end up getting the full deferred pension at retirement age. If the scheme runs into financial difficulties in the future, you could see your deferred pension cut via a S.50 order, as part of a restructuring of the scheme, with no floor to the cut which could be made. For example, some deferred pensions in Aer Lingus had their value reduced by between 45% and 60% as part of a restructuring of their DB scheme.
2. The scheme could be wound up and a transfer value offered which could be significantly less than what you are being offered now, and you would have no option but to accept it.
3. In retirement, even after the pension becomes payable, there is still a risk of a reduction in pension if the scheme was wound up or restructured.
4. If you were to die, a significant portion of your pension could die with you which is obviously not ideal for passing on your benefits to your family.
I now want to outline what I consider are the merits of taking an ETV.
1. If transfer value is enough, it could, depending on returns, pay a higher income than the DB pension.
2. If you avail of an ETV offering, you can pass on the value of it in death i.e. it goes into your estate and can be passed to your spouse/children/family.
3. You have much more flexibility and control over your income in retirement. By investing your ETV in a Personal Retirement Bond which will become an Approved Retirement Fund (ARF) when you begin to take benefits from it, you can dictate the amount you draw down from it each year to meet one off expenses. With a DB pension, you don’t have that flexibility.
4. By taking control of your pension in retirement, it removes the uncertainty over what your future income might become in retirement i.e. you are not impacted if the DB scheme decides to adjust the benefit payable to its members or not.
5. Taking the ETV and investing it via an ARF, this mechanism can allow you (a) access to your fund earlier than a DB pension and (b) you have the potential for a higher tax-free lump sum.
6. The value of your fund can increase over time with the return on the investment strategy.
7. Even if the transfer value doesn’t translate into the exact amount a DB pension might, you may have access to other sources of income i.e. rental income, and when combined with the ETV income, it is more than sufficient from a cash flow perspective.
Another question asked is do you wait and see if the ETV gets bigger? If the solvency position of the DB scheme remains the same, the ETV offer would be expected to increase for each year you wait to take your deferred pension.
However, there are a few things that could upset this increase.
If investment markets dropped significantly in the meantime and the solvency position of the scheme deteriorated the transfer value might actually be cut.
Secondly, if the scheme fails to meet the funding standard, there could be a cut in deferred pensions and hence a cut in the transfer value available.
Lots to consider and it’s important you get external advice from a trusted source, not someone involved with the DB pension scheme because there may be a conflict of interest.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie