Defined benefit pension schemes – should you stick or twist?

Many defined benefit pension schemes which have closed to new entrants are offering members enhanced transfer values (ETVs) in order to accelerate the eventual full closure of the schemes.

For those at the receiving end of such offers there are all sorts of considerations to factor in. “It’s a huge decision so don’t go into it lightly,” says Bernard Walsh, head of pensions and investments at Bank of Ireland.

The trade-offs can be significant, depending on whether you want the certainty of an annuity or a lump sum to invest.

It’s important to take a holistic approach to the decision, Walsh advises, one which looks at any other pension pots you may have. The decision should take into account whether or not your pension is your entire nest egg or if you have other assets to draw from. You also have to factor in issues such as health; poor health will have a bearing on your decision.

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“You may say ‘I’ll take the cash,’ because it might have more value to you,” he points out.

Others may be at a stage in life where their outgoings are huge – putting children through college, for example. In such cases gaining access to the enhanced transfer value can seem very appealing.

Whatever you do, you don’t want to regret your decision. “You are giving up something you will never get again because very few employers now offer a defined benefit scheme,” says Walsh.

Other issues to factor in include the future prospects of the employer. While there are protections in place, at the end of the day the promise to provide you with a pension for life is only as strong as the person or entity making the promise.

Though typically referred to as the Rolls-Royce of pensions, benefits under defined benefit schemes are not guaranteed. If the scheme’s assets are not sufficient to pay its liabilities and the employer isn’t able to plug the gap, the pension promised to you may have to be reduced.

If you do decide to go for the ETV you can opt to transfer the benefit into the defined contribution scheme you may have with a current employer or a personal retirement bond (PRB), which you take out yourself.

Also known as a buyout bond, a PRB is a particular type of personal pension contract where the only premium payment comes from a transfer payment from an occupational pension scheme. Rules around accessing PRB funds reflect the rules of the transferring pension scheme.

The value of a PRB at retirement depends on the transfer payment amount and the investment return achieved over the term to retirement.

Generally individuals can take a tax-free lump sum from a PRB and use the remaining funds to buy an annuity (pension) or invest in an approved retirement fund.

By transferring from a defined benefit to a defined contribution scheme, the investment risk passes from your former employer to you, which may or may not suit you.

If you have other defined pension pots from previous or subsequent employers, you might be comfortable taking on this risk yourself. If you have no such experience you might at least need more time to understand the full implications, particularly as, once the decision is made on an ETV, there is no going back.

Another consideration is about the advice you take and whether or not it is independent and takes the form of an overall financial review or solely looks at your pension.

“You need a very independent analysis of the current situation – it’s not a one-size-fits-all issue,” says Tony Delaney, founder and chief executive of SYS Group, a full-service financial consultancy whose head office is in Nenagh.

The fact that transfer values have dropped in the past 12 to 18 months as interest rates have risen will now also be factored into any decision making.

“We have someone whose transfer value was €2 million eight months ago and is €1.7 million today, though ironically they should get the same pension out of it because annuity rates have gone up,” says Delaney.

“But it is really down to your individual circumstances. That includes your health status, because if you are not in the best of health the best option may be to transfer the money into a personal retirement bond or PRSA, which is paid out on death.

Don’t just engage someone with a background in pensions on this one. For ETVs you need someone with a background in defined benefit schemes

—  Tony Delaney, SYS Group

“Maybe you want to retire as tax efficiently as possible. Are you married? Are you single? Maybe you have to factor in a spouse’s pension, which is normally 50 per cent. If you are single you might have no one to leave a pension pot to. If you don’t want to take an investment risk you might choose to stay where you are. If you do, you might look at your options.”

The nearer you are to retirement, the higher the transfer value tends to be. The rule of thumb is a transfer value of 20 times your pension, so if you are looking to get a €20,000 pension, you’d need a €400,000 pot, Delaney points out.

“Don’t just engage someone with a background in pensions on this one. For ETVs you need someone with a background in defined benefit schemes. There are just too many complexities. So don’t just get advice, get expert advice,” he says.