Should I take a Transfer Value from a Defined Benefit Scheme?

Defined Benefit Pension Schemes are the gold standard of pension schemes. It has been well documented that there are fewer and fewer of these schemes in existence due to the high running costs associated with them.  Pretty much all employers opting for Defined Contribution schemes when they are setting up new schemes for employees.

As much as there are no new schemes being set up, there are still a significant number of people who are still members of Defined Benefit Schemes. A lot of members are under the belief that the income they are projected to receive is guaranteed, however, a Defined Benefit scheme is nothing more than a promise by the employer that they will pay you an annual income from the retirement date of the scheme. The promise is only as good as the employer’s ability to meet it. The strength of the scheme will be dependent on current funding levels, future liabilities, interest rates, investment market performance and the overall performance of the company should they need to top up the scheme to avoid shortfalls.  Should the scheme run into difficulties, it will the members who are already in receipt of payment that will take priority.

 

Defined Benefit Preserved Benefit

When a member of the scheme has not reached the retirement age of the scheme, they are known to have a preserved benefit. In this instance, he or she must consider several issues before deciding whether to maintain this preserved benefit or opt to take a transfer value.

 

Solvency of the Scheme

This is probably the most important factor that needs to be reviewed before considering taking a transfer value. The current and anticipated solvency of the scheme should be assessed along with how committed the employer is to the scheme. If there a deficit in the scheme, how realistic are the employers plans to eliminate the deficit?

The demographic of the members should also be assessed. A person should assess where they are in the relation to other in terms of reaching the normal retirement age of the scheme. Will this put the scheme under further pressures if the older members live longer?

 

 

Some potential Benefits of Maintaining Preserved Benefit

• The preserved benefit will be adjusted with in line with CPI (if less than 4%) up until the Normal Retirement Age of the Scheme.
• A higher transfer value could be offered in the future should the solvency levels of the scheme improve.
• The employer is the one carrying the investment risk.
• When in payment, the member will receive a fixed income.
• Once in payment, there may be discretionary increases to the income being received.
• The transfer value generally increases the closer a member is to Normal Retirement Age.
• If the member dies before reaching retirement age, the full transfer value may be paid to their estate.
• There may be a spouse’s pension in place should the member die in retirement.

 

Some Potential risks/disadvantages in leaving the scheme preserved benefit in the DB scheme

• If deflation occurs before the normal retirement age, the preserved benefit will be reduced.
• The solvency of the scheme could deteriorate, thus decreasing the transfer value in the future.
• The scheme may wind up due to a deficit before the member reaching retirement age meaning they will only receive a part of their retirement benefit or in extreme cases be left with no benefit at all.
• The preserved benefit could be reduced, or the Normal Retirement Age extended in order to help improve the solvency of the scheme.
• In retirement, the pension payment may be reduced to help with the solvency of the scheme.
• Depending on the scheme rules, in the event of death, there may be a reduced pension for a spouse rather than paying out a transfer value.

 

Option to take a Transfer Value

When an individual leaves service, they have a statutory right for two years to opt to take a transfer value to another pension scheme. After this they may have the option to take a transfer value rather than keeping their preserved benefit, however, it will be at the discretion of the trustees. The transfer value will be based on actuarial calculations.

 

Some potential benefits of taking a transfer Value

• The individual may be able to access the benefit before normal retirement age. This can be from age 50 under a Buy Out Bond, whereas early retirement is generally not allowed in Defined Benefit schemes.
• The individual can control how the monies are invested going forward.
• The individual will no longer be subject to fluctuating transfer values due to the changing solvency of the scheme.
• The employer may offer an increased transfer value if there are solvency issues expected down the line.
• If a transfer value is taken, in the event of death, the full value of the pension will be paid out to estate rather than possibly a reduced spouse’s income if they remained in the DB scheme.
• The individual may be entitled to a higher tax-free lump sum under the new pension structure.

 

Some Potential risks/disadvantages in leaving the scheme preserved benefit in the DB scheme

• The solvency position of the scheme may improve in the future.
• There may be increased transfer values on offer in the future if the employer thinks there may be solvency issues.
• The transfer value will almost certainly increase the closer the member gets to Normal Retirement Age.
• The individual may be entitled to a lower tax-free lump sum under the new pension arrangement.
• The individual will be taking on the investment risk.
• The new arrangement will provide an uncertain and variable level of income in retirement.
• The individual will be subject to charges in order to establish the new pension arrangement whereas the employer effectively carries all charges in the DB scheme.

 

Making a Decision

This is a complex area with a number of factors to consider so it should be discussed with a professional financial planner. They will review not just the scheme but look at your overall individual circumstances to help you make an informed decision.

They will assess:

• Solvency of the scheme
• The Scheme Rules
• Your appetite for risk
• Current market conditions
• Other incomes you are expected to receive
• Anticipated expenditure in retirement
• The health of the individual

 

A financial planner should carry out cash flow modelling where they will be able to run through both scenarios with you to help with the decision. There is no right, or wrong answer and the decision will be very much dependent on individual circumstances.

 

Contact Us

Contact us if you are considering taking a transfer value as we will run through a full financial planning exercise to help you make an informed decision.