The importance of financial advice
If you are between 40-60 years of age and worked in the private sector, you may be fortunate enough to have a ‘Defined Benefit’ (DB) Pension, i.e. an occupational pension from a previous employer that amounts to a promise (not a guarantee) to pay a future retirement benefit annually (based on years’ service and salary). You may or may not be aware of the value of this potential pension option or the fund injection that this could provide towards your retirement pot.
‘Reduction in DB Schemes / 20% of schemes underfunded’
In the Irish private sector, there are few remaining DB Pension schemes (ref: Irish Pensions Authority website @ 12/2018, approx. 614 down from 22,220 in 1996) as employers look to shift the burdenof retirement provision to the individual. The remaining employer DB schemes are proving expensive to provide for due to the challenges of a low global interest rate environment reducing investment returns while increased longevity challenges employers funding commitment.
On the Pension Authority website an added concern outlined is that only 80% of DB schemes were fully funded at 31/12/2018 with many failing their minimum funding standard.
In recent years we have witnessed Irish Pension schemes collapsing and companies reneging on their commitment to pay existing and deferred pensioners, some high-profile companies include Waterford Crystal, Roches Stores, Aer Lingus, Arnott’s, and Irish Permanent.
These four headings need consideration in any evaluation of a DB Benefit Retention V Transfer Value
1. Financial Health of Scheme / Pensioners priority over DB Deferred holders
If as a deferred pensioner your plan is to wait until retirement for your annual defined benefit, the onus is on you to monitor the financial health of the scheme (sounds like a lot of hard work!), is it currently meeting its minimum funding requirements? if not, have the company made top-up payments to the scheme, demonstrating their commitment to DB pension holders. If you have concerns you need to reach out to the trustees or engage a financial advisor to work with you.
For deferred DB holders their concerns are magnified if they are some 10-15 years away from retirement and the company has trading difficulties, DB plans are exposed if an employer ceases business while their plan is in deficit.
Under Irish pension rules, deferred pensioners are potentially penalised in that their pension claims rank lower in payment priority behind existing pensioners.
For all the above reasons, advising an individual client on the benefits or drawback of their DB Pension V Transfer value option is some of the most detailed and important advice that a Financial Adviserengages in.
With the uncertainty regarding employers commitment to maintaining DB schemes, it is not surprising that many existing schemes are looking to quantify and reduce their Pension liability by offering upfront transfer values (often a multiple X the annual DB payment) to deferred pension holders, thereby crystallising the employers liability in exchange for the employee waiving their DB pension right at retirement. As a financial adviser, I regularly encounter deferred DB holders who naturally struggle to comprehend if the transfer value offered is attractive and how it might stack up as part of their retirement pension planning.
3. Fact-find Individual/Family
Firstly, as an experienced financial adviser, I believe there are no hard and fast rules that can be applied. Each transfer value must be considered in the light of the person’s individual circumstances, each person’s situation is different and you cannot commence to assess an offer until you have carried out an initial financial fact-find meeting with the individual and understand their family circumstances.
At the initial meeting the adviser needs to outline the current pension landscape to include any potential legislative changes, detail retirement choices (ARF’s V Annuities), establish the client’s risk appetite/capacity and how any potential tax-free lump sum pension payments interact with severance payments.
For such an important and potentially life-changing decision, it is advisable that the DB holder’s spouse/partner attend these meetings, so that all relevant parties are fully informed on how a transfer value can positively affect family wealth preservation, while detailing the negative, i.e. the spouse must waive the spouse’s retirement benefit if they opt to take a transfer value.
4. Adviser and Independent Actuarial input
While advice work on Transfer Values is comprehensive and worth doing, with any costs being worth the saving involved, it is vital to the integrity of the advice piece that the financial advisor acts at all times in a professional manner, adhering to a strict process, favouring neither option: a) Defined Benefit Retention, nor b) the Transfer Value.
The adviser’s role is to weigh up and lay out the benefits and drawbacks of each potential option, re-affirm that the adviser has fully understood the client position outlining and discussing the options with the client, that the adviser has reviewed the latest scheme actuarial valuation report and can opine on the schemes financial health. Finally, the financial adviser outlines and summaries the client’s options and then leaves the client with the ultimate decision.
Given the workload involved with either option a) or b) , I would recommend that the Financial Adviser agrees a fair fee in advance of any work undertaken so that there are no surprises to the client in a fair and transparent manner;
a) DB Retention–
b) Transfer Value-
With the material quantum of transfer values, I would strongly recommend that an independent Actuary contributes to the process preparing a written report to review and verify the veracity of the
employer’s transfer value calculation, outline the client’s options, the benefits he/she may waive and with respect to the transfer value to calculate the annual investment hurdle return rate that the client requires to earn to match the DB income promise.
I believe that this four-eyes approach (Adviser and Actuary) enhances the client’s comfort with this evaluation process, in what is for most individuals a very significant financial decision.
Summary and Action
I specialise in helping individuals to accurately assess the potential risk and reward of remaining in their old employers DB scheme versus taking a Transfer value.
If you would like to hear more detail on the options available to you, please get in touch and I would be happy to schedule a 15 min. chat on how I can help you achieve your retirement goals.