Should you transfer from a defined benefit pension?

I am going to set out the key considerations as I work through this post (so please resist the temptation to have a pop as this is work in progress).

The default position should always be this

It is generally a bad idea to take a transfer value from a defined benefit pension scheme for an average person.

So, the first question you should ask yourself is this; "why am I different?"

  • Above average wealth - you might not need the guarantees that the scheme offers
  • Linked to this, tax planning
  • Desire to access pension before normal retirement date, again this may be linked to wealth and creates a more tricky situation when linked to debt.
  • You may be living in a different country or plan to retire to a different country and need to consider these additional complexities.

Then ask yourself; "why am i considering taking the transfer now?"

a) Your employer's scheme is being wound up

  • You have to take a transfer and you should seek Independent advice on what to do
b) You have been sent a statement by the trustees and the transfer value seems like a lot of money

  • Most people have an unconscious bias toward a tendency to increasingly choose a smaller reward now, over a larger-later reward. The notion of discounting future rewards relative to immediate pleasure has a long history.
  • Its hard to "see" what we are really giving up in return for what looks like a substantial sum now.
  • You should take Independent Advice from a competent adviser who specializes in this area.
c) If I die the pension is lost

Here is a real case study to illustrate this point

John is 50 and has a deferred pension of €20,622pa payable from age 65. This is revalued each year up to a maximum of 4%pa. So he can assume the pension at age 65 is going to be more than €27,000 but that’s just €20,622 in today’s terms.

If he dies as a deferred member, there is a lump sum payment to his spouse which is currently €267,000
However, his spouse's pension payable in retirement is just €10,311

The transfer value today is €267,000

John reasons that if he dies in retirement, his spouse and family will be much worse off than if he took the transfer value.

  • On the face of it, this seems like a reasonable course of action.
  • However, taking a transfer isn't the only way to resolve this risk.
  • Assuming John is in reasonable health he could arrange a life assurance contract to provide a tax free payment to his spouse or civil partner in the event of his death and continue to receive the benefits of the pension if he and his spouse live long and healthy lives.
  • If he is in poor health and/or uninsurable, well that points towards evidence that taking the transfer value might be the best course of action
  • Put another way if John lives to be age 100, then remaining in the scheme will probably turn out to be the best course of action. Whereas if he dies tomorrow, a life assurance policy would protect his spouse and family against the loss.
  • So you should be wary about taking the transfer value to protect against something that can be insured through life assurance
  • The problem is that there is no “best before date” on your birth certificate

d) it’s my money, give me the cheque please

Today it costs you around €725,000 to obtain a comparable level of income from an insurer today assuming current annuity rates for a 65-year-old with 50% spouses pension and escalation of 1.5%pa. (i.e to exactly match the benefits provided by the DB scheme)

(Note to simplify the explanation I’m using current annuity rates available now rather than the more complex formula required by say the UK regulator.)

So, if John takes the transfer value of €267,000 it needs to grow to €725,000 in today’s money by age 65 in order to guarantee (via an annuity) he can match the benefits given up.

It doesn’t matter if John doesn’t want to buy an annuity, hates annuities or any other preference he might hold. The ONLY way he can guarantee the benefits given up for the whole of the rest of his life and that of his spouse, is by buying an annuity with the same spouses benefit and indexation.

We call this the “critical yield” and it gives John an idea of what he needs to do if he takes the transfer value now and wants to avoid being worse off in retirement.

By making some simplifying assumptions I’ve made the calculation easier:

Fund now €267,000
Fund required at age 65 €725,00
Term to age 65 15 years
Solve for real interest rate =inflation +6.89%pa on average.

So if John takes the money now, he has to achieve an average annual real return of CPI+6.89%pa every year for 15 years AFTER costs and charges (all else being equal) to be able to go to an insurance company and buy an annuity to match the benefits he gave up by taking the transfer value.

John is going to need to take a high investment risk to get anywhere near enough in the fund to match the benefits given up.

e) maybe don’t take the transfer now but take it later?

By staying in the scheme you allow the trustees and the employer to take all the risk and cost.

Using my earlier calculation as a guide what do you think the transfer value is going to be the day before John’s 65th birthday.

It’s going to be pretty close to the €725,000 in today’s money necessary to purchase an annuity to provide the promised benefits.

The difference is that John doesn’t have to do anything for this to happen. His transfer value is going to increase by a real inflation adjusted 6%pa so why not wait it out and take the transfer nearer retirement?






Some potentially good reasons for taking a transfer
  • Require access to funds (early retirement)
  • No requirement for pension in retirement
  • Inheritance Tax Planning
  • Ill health
  • Weak Employer covenant and Trust Deeds & Rule
  • Material one-off uplift provided
  • Ability to negotiate uplift
 
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Thanks Elacsaplau,

That makes much more sense to me. I look forward to your further explanations.

Marc,

I don't understand this. Can you elaborate please?

Marc said:
Here is a real case study to illustrate this point

John is 50 and has a deferred pension of €20,622pa from age 65
If he dies as a deferred member, the payment to his spouse is €267,00
His spouse's pension payable in retirement is just €10,311

The transfer value today is €465,000
Click to expand...
 
Bronte said:
As far as I'm concerned a defined benefit is the gold standard. My husband's company moved all new staff to defined contribution and sent in top notch heavy hitting suits to 'sell' it to the existing staff. Much like this thread and others they tried to bamboozle them with reams of documentation, slides and presentation. You'd literally be brainwashed into believing black was white.....
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Jeepers Bronte - tell us what you really think! Happy new year to you! As it happens, I agree with very much of this.;)

The document from the link below is interesting. In response to just one of WhiteCoat's excellent questions, it explains why companies might be very interested in making transfer value (TV) or enhanced transfer value (ETV) payments. In reading it, please bear in mind that the standard transfer value is based on the Minimum Funding Standard (MFS) and the clue is in the M here. Quite simply, it is a very weak basis of valuing the liability (i.e. the future pension benefit promise). In other words, the same actuary who values the liability at X for MFS purposes will value this same liability as X+ in the triennial/funding valuation, X++ to satisfy the accountants that the liability is being prudently valued and X+++ as the buy-out cost.

And don't think X+++ is completely off the scale...….when a DB plan winds up in the UK, it's the X+++ cost that the employer is facing and it automatically becomes a debt on the employer. (In the UK, other member protections kick in where the employer is insolvent.)

https://www.mercer.ie/content/dam/m.../Ireland/ie-2017-enhanced-transfer-values.pdf

In all of this, you can see how the interests of the member could get hurt by the top notch heavy hitting suits.

- The employee benefit (EB) consultancy wants to demonstrate a successful liability reduction campaign in order to justify its fees (i.e. it needs a number of members to transfers out);
- The sponsoring employer also wants reduced liabilities and the funding and accounting gains demonstrated in the flyer (i.e. it needs a number of members to transfer out) and
- The independent financial adviser to whom the member seeks advice may be conflicted. If, for example, the member does transfer out, and invests the TV with his agency, there is the prospect of the financial adviser receiving greater remuneration in the long-term than had the member simply left his entitlement in the DB scheme. (As Marc correctly pointed out there is also the possibility that the financial adviser does not really understand this complex area sufficiently.)

I am certain that some members have got mushed in the past because of the combined efforts of the three parties above in addition to poor regulatory protection for members. I don't envisage any meaningful changes anytime soon.
 
Our company did a hard sell on us to agree to close the DB scheme, fancy brouchers, PowerPoint presentations, short time frame, individual meetings with senior managers. The main driver for the company was accountancy certainties on the annual results as they will not have to make large allowances for future liabilities in the DB pension scheme. The calculations used to calculate the ETV were not disclosed so there was a perceived lack of transparency.

I think one important factor is that people like myself employed and paying into a DB scheme are in the main financially risk averse and want the security of employment with low risk DB pension. If I felt I was more of a risk taker financially maybe I would not be in this type of employment in the first place. My level of risk and my personal circumstances played a big part in my decision to stick with the DB scheme and not take the ETV. What I would be poor at assessing is will the company continue to fund the DB scheme until I die, my insight and skills are insufficient and so this is the risk I have taken. I can dig out and give my figures if anyone is interested.
 
Hi Clamball,

I think that the idea of sharing the details is very interesting. In this way, the debate can become much more real. If this works for you, it would be really important to anonymise all personal details (for your own security, etc.)
 
Gordon Gekko said:
I would take the €465,000 in a heartbeat.
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One thing people need to take into account if there is a shortfall in the defined benefit fund will the company be in a position to make up the differance long term , Is there a chance the company will be gone out of business,


I know already in Ireland the tax payers and people in defined contribution schemes bailed out defined benefit schemes it went under the radar at the time ,with people better informed now I see a time when it will cause problems ,I think EU forced the Government to bail out defined schemes ,I can see a time when people well start kicking back against unfair EU rules and questioning the unfairness on others not in defined pension schemes,


Just for the record I retired from a private Company Defined Benefit Scheme on retirement my entitlements to my retired benefit pension no longer are tied to the existing company fund,

People need to look and take into account the company under pinning there Defined Benefit and how/can it will be funded into the future when making up there minds ,

The above may not be very well explained but no poster covered the above points some are in a very good position to do so ,I am not sure Marc covered the above are all Defined Benefit Schemes safe if you decide to leave your funds in them having being offered to transfer funds out of defined benefit scheme and decided not to do so

You often find the rules of the scheme will work in favour of high earners who can leave and drain the fund on lower grades if problems start to show up in funding,


It is quite possible people who finish up on high final salary will drain the funds on people who work in the company who spent all of there working life in lower grade positions,
 
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Marc said:
John is 50 and has a deferred pension of €20,622pa from age 65
If he dies as a deferred member, the payment to his spouse is €267,00
His spouse's pension payable in retirement is just €10,311

The transfer value today is €465,000
Click to expand...

I'm a long time away from this but the TV in this scenario would be well less than 200k based on the set parameters the actuary has to work with.
This is the nub of the problem. I presume by 465k you mean this to be the properly calculated TV if the actuary was free to use his own parameters reflecting market conditions ?

The gap between the standard TV and the actual fund required to buy the benefit is huge but gets smaller as people approach retirement age
 
JoeRoberts said:
I'm a long time away from this but the TV in this scenario would be well less than 200k based on the set parameters the actuary has to work with.
This is the nub of the problem. I presume by 465k you mean this to be the properly calculated TV if the actuary was free to use his own parameters reflecting market conditions ?

The gap between the standard TV and the actual fund required to buy the benefit is huge but gets smaller as people approach retirement age
Click to expand...

I agree with all of this based on the bare details supplied. WhiteCoat has already asked Marc to clarify the figures.
 
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Elacsaplau I would put it more plainly than you did. The suits were there as slick oil salesmen. They would make money on you. The company would no longer have the cost of DB and my husband would be the loser. The only person there to counteract the experts was me. And wives/spouses weren’t invited to any of the hard sell.

As ordinary people, it’s mentally difficult to know it’s a hard sell when it’s done so expertly suited. And that’s the point entirely of it.

Sure I get for someone like Geko, or others, managing your own money might be a better way to go.
 
Clamball said:
Our company did a hard sell on us to agree to close the DB scheme, fancy brouchers, PowerPoint presentations, short time frame, individual meetings with senior managers. The main driver for the company was accountancy certainties on the annual results as they will not have to make large allowances for future liabilities in the DB pension scheme. The calculations used to calculate the ETV were not disclosed so there was a perceived lack of transparency.

I think one important factor is that people like myself employed and paying into a DB scheme are in the main financially risk averse and want the security of employment with low risk DB pension. If I felt I was more of a risk taker financially maybe I would not be in this type of employment in the first place. My level of risk and my personal circumstances played a big part in my decision to stick with the DB scheme and not take the ETV. What I would be poor at assessing is will the company continue to fund the DB scheme until I die, my insight and skills are insufficient and so this is the risk I have taken. I can dig out and give my figures if anyone is interested.
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Would love if you did this. The figures. And then have Marc tell us if you made the right decision. The documentation my husband received ran to several pages. And I don’t mean 20.
 
SBarrett said:
With the actuarial methods for calculating a transfer value of a DB scheme out of kilter with reality, staying in the DB scheme should always be the starting point. But the solvency of the DB schemes is always the big issue then and you should always get a copy of the annual and actuarial report to see what the employers intentions are for the scheme.

A lot of people prefer the option of the ARF and with it a potentially higher tax free lump sum. But you are then giving away all guarantees and taking on all the risk and costs yourself.



Steven
www.bluewaterfp.ie
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Why is the actuarial method for calculating the transfer value out of kilter with reality?

My husbands company is a solid billion dollar company. So I never thought there was any danger in the fund. As regards solvency.
 
Marc said:
The UK’s financial regulator has reversed plans to loosen pension transfer rules after finding a “significant proportion” of savers were wrongly advised to give up guaranteed retirement benefits.

Yet, still there is widespread evidence of mis-selling such as in the recent case of British steel or at least poorly documented advice.

the last pension transfer report I reviewed from a well-known Irish employee benefit consultancy fell well short of the UK standard of advice.
Click to expand...

Translation: don’t trust the so called experts.

- widespread mis-selling
- wrongly advised by so called experts
- regulated experts means nothing
- ETV is fake (what Steven said)
- Regulator locking the door when the horse has bolted
- Vulture advisors according to BB

Basically a load of ordinary people were conned out of their money. By experts. This is retirement money. Money you can never hope to get back. It’s absolutely disgraceful.
 
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Brendan Burgess said:
Hi Marc

That is an excellent idea. What happened to British Steel employees appears to be a disgrace although it's not clear to me if their losses are due to the changes in the pension scheme or the vulture advisors who exploited them.

Would the following title to your thread be appropriate...

"You should not transfer from a Defined Benefit Pension Scheme unless..."

I think that the bar should be fairly high.

Brendan
Click to expand...
What is a vulture advisor?
 
Bronte said:
Elacsaplau I would put it more plainly than you did. The suits were there as slick oil salesmen. They would make money on you. The company would no longer have the cost of DB and my husband would be the loser. The only person there to counteract the experts was me. And wives/spouses weren’t invited to any of the hard sell.

As ordinary people, it’s mentally difficult to know it’s a hard sell when it’s done so expertly suited. And that’s the point entirely of it.

Sure I get for someone like Geko, or others, managing your own money might be a better way to go.
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Take two scenarios:

- You can have an ARF of €1m

- You can have a non-State-funded defined benefit pension of €30k a year for life (or whatever the exact number is that €1m would buy you were it an annuity)

I would always choose the first option, because:

- The second one is not “defined”; it’s merely a promise from a fallable entity

- On death, the €30k typically halves, so the surviving husband/wife then gets €15k a year. With the ARF, the drawdown stays the same

- On the second death, the pension disappears, whereas with the ARF, kids get 70% of its value into their hands

- Yes, the ARF is subject to market risk, but that’s manageable, despite what doomsday merchants would have us believe
 
Gordon Gekko said:
I would take the €465,000 in a heartbeat.
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Gordon,

It looks like you were right to act as swiftly as you did as the offer is no longer on the table! I still don't understand this example and await an explanation. In your example above, I would also go with the €1m option but I'd suspect that in real life the pension foregone would be more than €30k each year.
 
As it happens I have a pension quote or whatever you'd call it at the moment, now it doesn't have a transfer value as I didn't ask for that option, it's a DB and this is for an early payment before normal pension date. The annual pension offered is 19k and the amount they value it at for that Standard Fund Threshold is 380k.
 
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Marc,

There are two errors in your updated analysis, as follows:

Marc said:
Here is a real case study to illustrate this point

John is 50 and has a deferred pension of €20,622pa payable from age 65. This is revalued each year up to a maximum of 4%pa. So he can assume the pension at age 65 is going to be more than €27,000 but that’s just €20,622 in today’s terms.

The transfer value today is €267,000

It could cost you around €725,000 to obtain a comparable level of income from an insurer today assuming current annuity rates for a 65-year-old with 50% spouses pension and escalation of 1.5%pa. (i.e to exactly match the benefits provided by the DB scheme)

(Note to simplify the explanation I’m using current annuity rates available now rather than the more complex formula required by say the UK regulator.)
Click to expand...

According to Irish Life, the relevant annuity rate is about 3% - making the target fund for €27k p.a. pension equal to €900k


Marc said:
His transfer value is going to increase by around 6%pa so why not wait it out and take the transfer nearer retirement?
Click to expand...

This is not correct. Please refer to the guidance notes previously provided.
 
Gordon Gekko said:
Take two scenarios:

- You can have an ARF of €1m

- You can have a non-State-funded defined benefit pension of €30k a year for life (or whatever the exact number is that €1m would buy you were it an annuity)

I would always choose the first option, because....
Click to expand...

Hi Gordon,

Your choice may not change and may very well be the right one (certainly for someone with your investment liathróidí!), but I think the relevant comparative figures will be closer to the following than those used in your example.

Say you were in a DB plan with a level (non-escalating) pension of €43,000 with an attaching spouse's pension of 50%, the TV on offer would be approximately €1m.

The annuity rate for such a pension is c. 3.8%, meaning that if you used the €1m to purchase an annuity, you'd end up with an annuity of €38,000 p.a.

The original question is whether to elect to transfer out of a DB plan. So for someone electing to transfer out, the question is whether one would prefer €1m in an ARF or c. €43k p.a. in a DB plan. (I suspect that you would still go for the €1m but it's less of a clear cut than the figures used in your post).

One point to remember is that the standard TV is at its best value just before retirement - the further out from retirement one goes, the weaker the basis becomes. In addition to the bare numbers, obviously there are a pile of other factors in play at a personal level.
 
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