Many employers who have closed defined benefit pension schemes to new members and new accruals are seeking to wind them up completely over time by offering members what are known as enhanced transfer values.
This involves a calculation of the value of the income a member is due to receive from the scheme when they retire and offering an additional sum on top of that to buy them out.
Some of these offers may appear very tempting on the surface, but people should be very cautious before signing on the dotted line.
“These enhanced transfer value exercises warrant close scrutiny on every occasion,” says AIB head of retirement planning Jim Connolly.
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“Some of the uplifts can be eyewatering, whilst others can be negligible. Either way, the decision to accept or reject it should be based on several factors. These factors include your health, your need for income, how close you are to retirement, your other assets, your confidence that the sponsoring employer will continue to support the scheme, the lump sum you might get and the likelihood that the employer might make a subsequent higher offer in the future.”
Getting good financial advice is crucial, according to Shane O’Farrell, director of products at Irish Life Corporate Business.
“Deciding to give up a pension for life in a defined benefit scheme in return for a transfer to a defined contribution scheme or a personal retirement bond is a big decision,” he says.
“As clichéd as it is to say it, this is definitely one of those situations where members should absolutely always get independent financial advice. In fact, when an employer offers this choice to members, they generally make getting financial advice a mandatory requirement for any interested members before making a decision.”
O’Farrell explains that the financial advisor will take account of a wide range of complex factors including likely benefits from the defined benefit scheme, the financial health of the scheme, the strength of the employer’s covenant, the member’s own financial circumstances including retirement plans and other savings, taxation in retirement, and the member’s attitude to risk and investments in general and even their health status and so.
“So, given the range of factors that need to be taken into account, it’s easy to see how invaluable expert financial advice is when weighing up the options here,” he adds. “The best outcome will very much depend on the circumstances.”
Mercer Private Wealth principal Chris Carlile says it is possible that members could expect a higher overall pension benefit at retirement from an enhanced transfer, depending on investment returns in the destination defined contribution plan.
“The member’s attitude to investment risk and return is crucial as the capital value of their pension benefits will fall or rise with investment markets in a defined contribution arrangement.”
He also points out that there are ways for a member to increase their overall tax free lump sum entitlement by taking an enhanced transfer.
He also highlights some of the disadvantages.
“If electing to transfer, the investment risk in relation to the pension fund passes from the former employer, to the scheme member. Investment into an ARF, for example, should be based on the level of investment risk you are comfortable with and should take into account your financial circumstances and goals. It is important to understand that the value of your ARF can fall as well as rise, depending on which funds or assets you invest in.”
Increased longevity also presents a risk.
“As people are living longer, they will have to make their retirement savings last longer,” he notes.
“If you exercise the ARF option, you could fully use up the value of your pension benefits in your lifetime and find yourself without a retirement income other than the State pension.
“With a defined benefit scheme your pension will continue to be paid for your lifetime. Valuable death in retirement benefits can be surrendered by taking a transfer value. For many members the benefits provided by the defined benefit scheme under the traditional options will be in their best interest.
“Before taking a transfer value, you should have a clear understanding of the reasons for transferring and the potential financial impact. Nobody should take a transfer value without first getting professional financial advice.”