Last year nearly 1,899 pension buy-out bonds, valued at nearly £40 million, were purchased; the previous year 1,270 bonds were bought for a total of £23 million. This sharp rise in the buy-out bond market reflects both the changing working pattern in our society and the fact that buy-out bonds are a source of business for the life and pensions industry. Their purpose is to provide an investment option for those people with preserved pension benefits accumulated since January 1991, the date from which no occupational pension contributions / funds can be refunded when a pension scheme member leaves their employment.
Buy-out bonds are purchased on a pension member's behalf - usually, but not always, in consultation with the member by the trustee of their occupational pension plan. The bond purchase option must be exercised within two years of a person leaving a company. (Until then, the vested interest is left with the existing scheme.)
Buy-out bonds are usually deemed to be most suitable for people who become self-employed when they leave, who are employed as a freelance or contract employee or who are simply unsure whether they will join another company with an occupational scheme.
The idea is a good one: the buy-out bond travels with the person throughout their working life and if they do end up joining a new company, the service that had accrued in their previous occupational schemes would be taken into account when their bond transferred into their new scheme.
What many people do not realise about buy-out bonds is that unlike the straightforward transferring of vested pension rights from one company to another (another option for someone leaving a pension scheme), trustees of a new occupational scheme are not legally obliged to accept a transfer payment from a buy-out bond. If this happens, the employee will not be able to use the service accrued with a former employer to meet the five year service rule for joining the new scheme. Another disadvantage of transferring previous pension rights and value into a pension buy-out bond, is that the cash transfer value offered will not reflect the bond fund value purchased by the member.
"Recently I dealt with a client whose pension scheme trustees were leaning towards the purchase of a buy-out bond for this person," says Aidan McLoughlin, a pension and tax lawyer with the feebased advisers FEN Ltd. "They stated that his vested pension rights in the company's defined benefit scheme, in which the company promises to pay a pension directly related to his years of service and last year's salary, was worth £150,000. After an independent review, however, we determined that he would need to purchase a bond with a value of £280,000 to match the benefits that his old scheme provided. Under those circumstances, we recommended that he take the other option open - i.e. to stay put and preserve his existing benefits with his old company." Upon retirement age, Mr McLoughlin's client would then receive a pension from his old company. According to Mr McLoughlin, there is a big financial incentive on the part of insurance companies and their sales intermediaries, who are paid commission, to encourage trustees to transfer employees' vested interests into buy-out bonds.
Employees leaving a company need to take independent advice - separate from any advice provided by the company - to determine whether they should be transferring their vested pension benefits out of their old scheme at all. "The potential is there for the kind of transfer scandal that we have seen in the UK," says Mr McLoughlin, who also believes the questions raised by Tony Gilhawley about the status of buy-out bonds "needs to be clarified" by the Pensions Board.
