BACKGROUND
Enhanced transfer values are becoming more prevalent as companies aim to reduce their pension scheme liabilities. Here, we detail the rationale behind the notion of enhanced transfer values and the factors you should consider when reviewing an offer, and how it compares to your defined benefit pension.
Low expected returns from investments and increasing annuity prices have resulted in higher contribution rates being required to fund benefits within defined benefit schemes. Many employers have concluded that DB pension schemes are now just unaffordable with most schemes either being closed to new entrants or, in an increasing number of cases, having benefits restructured or wound up.
One approach being adopted by an increasing number of employers is to offer their members an attractive transfer value to encourage them to leave their defined benefit pension behind. The offer of this “uplifted transfer value” requires careful deliberation before electing to accept or reject the offer. Capitalised values of pension annuities can appear very large when compared to the regular pension, however, the cost of purchasing the same benefit and other ancillary benefits such as spouses pension and indexation can make these benefits almost impossible to replace outside the scheme.
WHAT’S AN ENHANCEMENT?
In theory the transfer value of your preserved benefit in a defined benefit scheme should be the present value of your projected future pension, with allowances for future uncertainties such as interest rates, inflation, possible future pension increases, revaluation of pension amounts pre-retirement, and mortality assumptions. In the past, the size of transfer values on offer were similar to the economic value of the future pension, based on realistic assumptions. However, in recent years, with the decline in the funding levels of pension schemes, transfer values payable have fallen.
The “enhancement” is added to the statutory minimum that the employer must pay you to leave your defined benefit pension behind. This minimum is defined by Pensions Authority regulation and Society of Actuaries in Ireland guidance. Enhancements to the statutory minimum can vary in an enhanced transfer value exercise. You could receive for example an offer of 130% of your Standard Transfer Value.
WHY WOULD YOUR COMPANY OFFER YOU AN ENHANCED TRANSFER VALUE?
Your company may want to reduce long term costs; with less future pensions to pay, it removes the uncertainty around how much they will cost by making a fixed payment now. The settlement of liabilities will generally be recognised as an accounting gain to the company. It also de-risks the plan, removing some uncertainty, as well as reducing future administration costs for the scheme.
FACTORS TO CONSIDER
The main issue for you is to consider if the offer is “good value”. In assessing the transfer value, it is appropriate to compare the offer to the estimated economic value of your preserved pension benefit. This is the pension that you would have built up to the date of leaving the Defined Benefit scheme, with service frozen in respect to your pension after this date.
We have seen cases where the economic value of the DB pension was significantly higher than the transfer value offer, for example a DB benefit that included a generous spouses’ pension. In other cases, the transfer value offer made more sense perhaps with a scheme that has solvency issues and the client wished to have more control over their pension fund. You should always consider the solvency of the scheme when they are deciding whether to stay or leave.
Key Factors to Consider:
• Is the offer considered good value versus the economic value of your pension?
• The scheme may be wound up in future, dependant on its funding position; by taking a transfer value you remove this future uncertainty.
• By taking out the transfer value you have more control over your pension, whereas your DB pension benefit is based on salary and service. The DB pension however, if the scheme remains solvent, is a guaranteed pension benefit.
• More control requires taking on the investment risk of the pension, and an increased burden in terms of pension management pre -retirement.
• If you have other pensions, taking the transfer value could simplify the management of all your pensions and the ability to consolidate funds.
• The ARF option is available to you at retirement by taking the transfer value option, whereas the ARF option is not currently available with a DB pension. This could pose a greater risk however as there is also the risk of funds running out in retirement with the ARF option.
WHAT YOU CAN DO WITH YOUR TRANSFER VALUE
Should you choose to accept an enhanced transfer value offer, your options will usually be: –
A. Leave funds invested until Normal Retirement Date:
1. Within a Defined Contribution company pension plan
2. Within a Personal Retirement Bond, which gives you personal control of the management of the pension and flexibility regarding when you access the benefits
B. If no longer an employee and over 50, you may also have the option to retire your pension immediately, with the benefit options being:
a) Traditional route option of a retirement lump sum, based on salary and service, plus an annual pension by purchasing an annuity, OR
b) Alternative option of a retirement lump sum, up to a maximum of 25% of the fund value, plus the remainder invested in a post retirement fund called an A(M)RF which you can subsequently draw down over time as you require.
It is important to consider that, as per the above, you may not have immediate access to the full transfer value as cash. The funds are reinvested in other pension products until they can be retired, which you control and ultimately carry the investment risk. However, in certain circumstances, you could retire the pension immediately and access the funds.
SUMMARY
Evaluating an offer of an enhanced transfer value is complex. Ultimately, it is your decision and it is your own financial circumstances and plans that will determine the option chosen. The quantitative aspect of comparing the value of the future defined pension benefit against the transfer offer is just one part of the decision process. The risks associated with both options must also be carefully considered.
It is recommended that specialist advice be sought when assessing the various considerations around enhanced transfer values. While each employer is obliged to provide access to an advisor, it is important to consider any potential conflicts of interest and choose an independent impartial advisor. Each transfer value offer analysis is different and complex, with your own individual circumstances ultimately deciding the recommended course of action.
Warning: This document is for general information purposes only and does not purport to give financial advice. You should consider your own personal financial situation, objectives and particular needs before acting on any information provided in this document and seek personal financial advice if required.