Defined Benefit Pension Schemes - Should you stay or go?
The viability of Defined Benefit Pension, (DB), schemes in Ireland continues to be a highly debated topic following the recent release of the 2016 Pensions Authority Irish Defined Benefit Statistics Report which highlights further declines in numbers. Managing the risks associated with these schemes has never been more challenging as members live longer, bond yields fall and investment volatility continues all within the constraints of a complex governance and regulation environment.
Employers are growing increasingly uncomfortable with the financial risks associated with these schemes, viewing them as commercially unviable over the long term. There is also a real concern about the declining number of active members remaining to support the overall membership. If you are one of the estimated 629,000 DB members in Ireland, you may well ask yourself what this means for you and whether there is anything you should be doing?
You firstly need to understand that a DB pension is effectively an ‘I.O.U.’, a promise from your employer to pay you a defined annual income at your specified retirement age. A promise that is only valid if the money is there to meet the liability at the appointed time.
The report confirmed the overall DB membership as being split 18% active members, 16% pensioners in payment and 66% deferred members (past employees). While this is of concern, a more worrying aspect is that 163 of the 628 schemes are not meeting the “minimum funding standards”. Furthermore, 181 are frozen and 25 are currently being wound up. We are seeing more and more employers either closing the scheme to new entrants, to future accrual or winding them up altogether. In these instances, future pension funding is often redirected to a Defined Contribution, (DC), arrangements whereby the actual fund value at retirement shapes what pension benefits are available – a very different prospect to the pre-defined benefits afforded under a DB scheme structure.
So what does this mean for you?
Your options depend on where you sit within the DB scheme membership hierarchy.
- As a ‘pensioner in payment’ who is currently drawing your pension benefits, you are in a more secure position than most, albeit not fully protected. The trustees retain the right to apply for a reduction of benefits and usually succeed if it is deemed necessary for the survival of the overall scheme. Although the scheme Trustees are unlikely to agree, the only sure way to protect your position is for them to purchase an open market annuity income on your behalf, mirroring your existing benefits
- As an active current member of a DB scheme, options are limited unless your employer approves a transfer value to a DC occupational scheme under the same employment. We suggest you keep a watchful eye on the funding status of the scheme and proactively query your employer’s current and future commitment to the scheme.
- As a deferred member, you have more options available. You can remain a preserved member or transfer out to an alternative qualifying arrangement. You have the automatic right to transfer out within 2 years of leaving service or thereafter with trustee approval. The appropriateness of each option needs to be assessed in context of your personal position.
Where a transfer out of the DB scheme has been approved, you need consider the following in context of your personal circumstances:
- Are you confident about the viability of your current DB scheme?
- Can your transfer value provide you with a similar income by way of an open market annuity or by drawing down an equivalent income from an approved retirement investment fund?
- What level of risk is needed to provide you with a fund capable of delivering comparable income?
- What growth rate is needed to support your required income to avoid ‘bombing out’?
- Which option provides optimum lump sum benefits?
- Is flexibility and control around your income in retirement important to you?
- What is the tax treatment on death for each option?
Although the future for many DB schemes may not seem bright, that is not to say they are all doomed and won’t deliver. These are complex structures and understanding their intricacies can be daunting however neither procrastination nor denial are options! A DB scheme is potentially one of your most valuable assets and as such we encourage you to take a proactive interest in it. Given the depth of complexities involved, we strongly endorse taking impartial and expert advice to help you navigate your way around. We suggest you:
- Request your annual benefit statement to include details of entitlements accrued to date and the projected benefits at normal retirement age.
- Request a copy of the Trustee annual report for am overview of the current member split and funding position. If in deficit, ask what plans have been put in place to address this?
This is an area of financial planning that we in Wealth Alliance have much expertise. We can provide you with a thorough overview of all the moving parts, to walk you through your options enabling you to make an informed decision. There is no one shoe fits all solution in these instances however exploring your options now will safeguard you against the unknown down the line.
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