Could your Defined Benefit Pension be worth more than your home?
Estimating the Transfer Value of your Defined Benefit (DB) Pension Scheme
If you are fortunate enough to have a Defined Benefit Pension Ireland, you will have seen your transfer value increasing in the past few years.
There is no simple way to calculate the transfer value of a Defined Benefit Scheme. The calculation involves any factors which are just not readily available to the members.
While it can be frustrating from a time point of view, there is a reason why the scheme administrators / trustees usually take several weeks to produce a full Pension Benefit Statement.
If you have received a transfer value and are trying to determine if it is a fair value, please review our previous post on whether to take a DB transfer or retain a DB benefit?
If you’re looking for a more immediate answer, taking into account your personal circumstances, get in touch with our team and find out how we can help you determine what your pension is worth. As you will read below – it could be worth more than your home!
Fewer DB Pension Schemes. 20% underfunded.
Defined Benefit pensions are old legacy pensions offered by employers to employees, and were once considered the ‘gold standard’ of pensions.
In recent years, there are far fewer DB schemes in existence; some 600 in Ireland, now down from 2,500 in the mid-90’s (Irish Pensions Authority). Of these in existence, the Pensions Authority opined on their website that some 20% of all DB schemes at 31/12/2018 were failing their minimum funding standard, raising concerns that employers may not be able to meet their DB promise to both active and deferred members.
Many DB schemes have been closed to new members due to the cost of providing for them, which has been exacerbated in the last decade with reducing bond yields due to Central Banks’ QE policy, low interest rates, while increased pensioner mortality rates have challenged employers’ funding commitment.
Recently, we have also seen many companies look to manage or reduce their pension risk through offering both Transfer Values and Enhanced Transfer Values (ETVs).
In this article, we will look at why these Enhanced Transfer Values and Transfer Values are worth detailed consideration by both active and deferred DB members, as well as some reasons why larger companies are increasingly using ETVs as a means of managing their pension risk.
As Financial Advisers, we have seen in the last 18 months several Irish based companies offering very generous Transfer Values and ETVs, some at the higher end of the range being 25 to 30 times the annual DB promise. These include large corporates such as Diageo, Ulster Bank, BOI, KBC and semi-states An Post and Eircom.
What is an Enhanced Transfer Value (ETV)?
An Enhanced Transfer Value (ETV) is a balance sheet exercise by a company to materially reduce its pension risk (liability management) and improve the scheme’s funding position.
It amounts to offering both active and deferred members an increased transfer value based on a combination of:
- A Transfer Value from the DB Scheme, for example a deferred member may have an annual DB benefit of €16,000 based on salary and service, by reference to the company’s funding standard the actuarial Transfer Value might be some 18x, or €288,000.
- To make the Transfer Value more attractive to existing members, a company with sufficient resources may offer a pension enticement (ETV) top-up of say, €200,000. In this example it is the company who pays the enhancement sum
In our example, the combined Transfer Value is now some 30x (€488k/€16k) and merits detailed analysis and consideration by the scheme member. It is the company’s decision to set the uplift basis and is a balance between high take up and the availability of resources.
Why do companies offer ETV and Transfer Values?
Companies will offer ETVs and Transfer Values to demonstrate to their stakeholders that they are managing the pension risk on the balance sheet, reducing the scheme’s liabilities and the associated risk. They also reduce the scheme’s long term costs of operation.
For financial institutions, these exercises can have a positive impact on their capital requirements.
Benefits to DB Members
- They allow deferred members (over 50 years age) the option to take their pension benefits immediately and access a tax-free lump sum.
- Give more control over your benefits and the ability to consolidate with other pension holdings.
- The member potentially receives a higher tax efficient retirement lump sum, with the potential for higher retirement income (dependent on investment strategy).
- These ETV and Transfer Values often represent particularly good value and through re-investment (in a Personal Retirement Bond or PRSA) and potentially allow the member the opportunity to match or improve the original DB promise.
- It allows more control over tax planning post retirement.
- Preserves the full fund value on death for the member’s estate.
- A member may require early access to their pension due to ill health, or may not value the spouse benefit of a DB (if single). An ETV may then suit his/her personal circumstances.
Caution
For married members, acceptance of the ETV or Transfer Value means the spouse’s Defined Benefit pension must be waived. An ETV or Transfer Value is not a suitable option for all DB members, and it is highly recommended that the owner engages an experienced financial adviser to assess his or her own unique circumstances, financial situation, and retirement targets to make the most informed choice for the individual and their family’s financial planning.
No decision should be made on accepting a Transfer Value without professional advice. Detailed cashflow modelling, even with a relatively small annual DB pension, can be worth a lot of money in terms of a Transfer Value.
The individual must be comfortable managing their pensions and wealth in retirement. By working with an experienced financial adviser, you can select and review annually a suitable long term investment plan.
5 reasons you might consider an ETV
- You are comfortable managing investment strategy and plan to access funds for early retirement.
- Where the once-off ETV is extremely attractive, in some situations a company’s HR will engage with you directly, with the ability to negotiate their own uplift.
- You want the ability to pass on your pension wealth to your family and dependents.
- You are consolidating a few pension benefits and want ownership of your investment decisions.
- In the event your health is compromised or you have reduced life expectancy.
With government bond yields at historic lows, this has increased the quantum of Transfer Values in recent times, as the discount rates used in these calculations are linked to these low / negative yielding government bonds.
With inflation expectations now gaining momentum, now is timely for Defined Benefit Pension holders to enquire for ETV and Transfer Value offers.
If you would like to hear more detail on the options available to you, get in touch with us today.
