"To transfer or not to transfer? Do you stay on your employer's Defined Benefit Pension Scheme or look for an alternative? Gerard O'Brien gives us the low-down on both options."
There is currently a lot of discussion surrounding employer-sponsored final salary / defined benefit pension schemes, with some people considering transferring out of such schemes into more personalized pension schemes.
In this article, I will look at the benefits of staying in the defined benefit scheme and the benefits of transferring out, whilst also examining the risks associated with both options.
So, what is a Final Salary / Defined Benefit Pension Scheme?
A defined benefit (DB) pension scheme is a pension arrangement, managed by your employer, which attempts to provide members with retirement benefits based on a set of calculations, based on the following:
- a member’s salary at their retirement age;
- and their pensionable years of service.
The retirement benefits under such a scheme traditionally provide for the following at retirement:
- a lump sum of up to 1 ½ times final remuneration
- and an annual pension payment of up to 2/3 final salary.
As you can see from the above clearly defined benefits, these final salary schemes are considered by many to be the ‘Gold Standard’ for pensioners as they reach retirement. Traditionally, you would rarely have seen anyone even consider transferring out of such schemes.
However, nowadays many businesses have decided that their defined benefit (DB) provisions are no longer economically viable and they are examining whether this type of pension scheme can continue to be afforded to employees going-forward.
There are typically only a couple of possibilities open to a business wanting to deal with this issue: one of the options open to the trustees of the scheme is what is known as a pension ‘transfer value’ (TV). Consequently, many deferred members (x-employees) in DB schemes are now being offered transfer values and even ‘enhanced’ transfer values if they leave their scheme. This can be an attractive offer to many as the offer can be high; however, it is important to understand that there are many aspects to be considered in deciding whether to accept such an offer.
What is an Enhanced Transfer Value (‘ETV’)?
In brief, the trustees who run the scheme convert your designated benefits in the scheme into a cash sum. This is called the ‘transfer value’ (TV).
However, some employers are now offering their deferred members an additional financial inducement to encourage them to transfer out of their defined benefit pension scheme. This incentive is known as an ‘enhanced transfer value’ (ETV).
What happens if I accept the transfer value?
If you decide to take the transfer value on offer, you are transferring the accountability and responsibility of the management of your pension assets from the trustees of your current DB scheme to a personal pension scheme chosen by you. You will need to receive detailed financial advice in this area to make sure the new personal scheme matches your requirements in terms of your income requirements, targeted growth rates, portfolio risk, tax and succession planning. It will be your pension to manage and look after.
Why would you not accept the transfer value of offer?
- You might be confident that your employer-sponsored DB scheme is very well-funded and feel that it is highly likely that it will pay out the expected annual DB pension in retirement?
- You might feel that they may offer you an even higher transfer value in the future?
- You may simply prefer a more well-defined level of income in retirement and it may not suit you to accept the risks involved in choosing your own personal pension scheme?
However, why might you consider accepting the transfer value?
- You might want to access a portion of your pension benefits now, as you can potentially access your pension from age 50 onwards in the new personal scheme?
- Maybe you maintain that the solvency of the scheme may deteriorate even further as the year’s go by, which could eventually lead to a reduced transfer value offer in the future?
- And finally, this is usually the main concern for many pensioners, is a fear that if you do stay in the DB scheme as a deferred member, that when you do reach your retirement age that you might not receive the annual pension benefits promised due to scheme under-funding / insolvency / scheme wind-down, as examples.
Who can you talk to as you look to make your decision?
I frequently meet customers looking to discuss the positives and negatives associated with their specific transfer offer – whether it be a standard transfer offer or an enhanced offer. We always start by discussing and assessing the client’s unique personal circumstances and financial position prior to making any important decisions.
Experienced financial planning advisors can support customers by:
- Helping them to examine the benefits they may give up if they transfer out of their employer’s scheme contrasted with the benefits with those of staying within the scheme;
- Evaluating the level to which their employer’s pension scheme is funded and its solvency, and the affects this may have on the benefits in the future;
- Deliberating over the advantages and disadvantages of the actual current transfer value;
- We also assess our customers overall financial circumstances, such as any other additional sources of income e.g. employment income, property income, state pension, spouses pension, investment and dividend income;
- It is vitally important to also discuss the various options open to them with their spouse / civil partner, as the decision will unquestionably affect them too;
- Finally, we would also identify and review other issues and potential risks associated with the current scheme, for instance: Is the current scheme being wound up? Are the trustees proposing any further cuts to benefits and are they considering any deficit reduction plans?
It is important to recognise that taking a transfer value offer from a DB scheme is an irrevocable decision and you need to review all your pension options prior to making such an important decision. I always suggest that in the first instance that you should seek the relevant information and guidance from the scheme Trustees and once you have these details, you should then proceed to discuss your retirement options with your local Certified Financial Planner (CFP).
Disclaimer: All data and information provided within this article is for informational purposes only. Heritage Wealth Management Limited makes no representations as to accuracy, completeness, suitability, or validity of any information and will not be liable for any errors, omissions or delays in this information or any losses, injuries, or damages arising from its use.