Defined Benefit Schemes (DB) are pension schemes that provide a promised benefit to employees based on years of service with an employer and, in most cases, their salary at date of retirement.
The Pensions Authority has the following definition:
“Final Salary Defined Benefit (DB) Schemes are occupational pension schemes that provide a set level of pension at retirement, the amount of which normally depends on your service and your earnings at retirement or in the years immediately preceding retirement”
An alternative definition by the legal profession in Ireland is more likely to be the following:
“Final Salary Defined Benefit (DB) Schemes are occupational pension schemes that may provide a set level of pension at a future date, the amount of which not only depends on your service and your earnings at retirement or in the years immediately preceding retirement but also upon the ongoing funding of the Scheme by the Employer and the ability and willingness of the trustee to enforce such funding”
The issue is therefore that though we see these schemes in Ireland as a guarantee and a “rock solid” promise by the employer, they are in fact dependent on many factors that if not in place or enforced could result in the benefit being reduced or not paid at all.
In Ireland we have had many examples of schemes closing, collapsing or facing a serious challenge to make sure the benefits are paid and therefore a member of a DB scheme when they are looking for advice needs to be aware of the risks in staying as well as leaving the DB Scheme. Examples to look at are:
Important issue in Ireland that differ from the UK for example in relation to DB schemes are as follows:
- All DB Plans are vulnerable if a sponsor ceases trading while the Plan is in deficit
- Due to the Priority Order (where pensions in payment are accorded more security) active and deferred members are more at risk
As a result, DB pension schemes and the question that members are faced with (should I stay or should I go? ) are without doubt one of the most important, specific and individualistic advice we can provide.
In helping members of DB schemes make a decision the advisor must be at all times professional, thorough and have a lot of understanding of the plight that the member faces. That is because the advice is very individual in nature and what works for one client may not work for another. There is no one size fits all when it comes to advice around DB schemes and as a result, it is important that a strict process is followed on all cases so that all areas are examined and understood by the member. The following is an example of a useful “roadmap” for DB Transfer Advice:
- Hold an Initial Meeting with a strict detailed Agenda, for example:
- Pensions and Awareness of the Changes in Legislation
- Current Benefits and the Clients understanding of same
- Approved Retirement Fund v Annuities
- Importance of age 60
- PRSA as an alternative
- Mandatory Drawdown
- Personal Asset
- Taking a Transfer – Pros and Cons
- Transfer Options
- Access to the Pension
- Interaction of Pension Scheme with Severance Payments
This is not exhaustive, but it covers most of the areas that need to be addressed.
- Prepare a Report: After the meeting it is important that the following information is collected:
- Detailed information on the scheme along with a note of retirement options. Included in this will be a transfer value figure the scheme is willing to pay out now for the member to forfeit any future entitlement.
- Calculate the hurdle rate (i.e. what does the transfer value have to earn per annum to match the benefit been given up) for the employee
- Calculate the difference in potential lump sums available under both staying and leaving the scheme
- Examine the death benefits under both staying and leaving.
- Obtain a copy of the Trust Deed and Rules. Does it mention any restrictions on wind up placed on the employer and/or the trustees?
- Copy of the last Actuarial Report. Is the scheme solvent? Is there a surplus or a deficit? Has a plan been put in place to fill the deficit?
It would be very unusual for a recommendation not to state to stay in the scheme. The issue though is that there are other factors at play that may influence the member of the DB scheme to look for the transfer.
- Follow Up Meeting: This meeting will recap on the initial meeting and will go through the Report that was prepared. In addition, though it needs to address the following:
- How close are they to Retirement?
- How confident are they in the scheme winding up? The copy of the recent Actuarial Report will answer this question
- If there is a deficit in the scheme currently how is it being handled or treated by the trustees and the employer?
- Is there a chance of a lower or no transfer value in the future?
- Is there a chance of lower benefits in the future?
- Will more people retire ahead of the client given his/her age?
- Is there a proposal for a Section 50 Order in with the Pensions Authority that will reduce their benefits?
- Is the Scheme planning to wind up?
- Has the Client got Ill Health Issues or Low Life Expectancy?
- Is there an Enhanced Transfer Value being offered?
- Is a Higher Lump Sum important to them given say their personal debt situation?
- Does the client simply want the ARF option?
- Is the client close to a Standard Fund Threshold of €2m?
- Are they able to handle the Investment Risk?
All these questions have to be taken into account in the follow up meeting so that the advisor has knowledge of all the issues and the member is aware of their impact on whatever their decision is. There may be very specific areas that might concern a client, and these will be afforded greater detail and discussion in the follow up meeting.
Once it has been decided by the client that they want to move out of a DB scheme a comprehensive Suitability Letter should be prepared by the advisor outlining the client’s circumstances, benefits, choices, costs and reasons for their decision. The Client then can have time to reflect and see their choice in writing and what it might mean, and do they still then agree or disagree with the advisor’s interpretations before proceeding.
So, there are specific issues with a DB transfer and as said, it is the most specific and individualistic advice we advisors will ever give. It is not done quickly, and many factors need to be considered. Our job is often to show the client the options, but the decision must rest with them. There is often no right or wrong answer and different members will make different decisions based on their own circumstances. However, they must have all the facts and be able to compare as much as is possible the pros and cons of this very big decision.
Derek Ryan is Head of Pensions in Smith & Williamson in Dublin. He runs an annual seminar for members of Defined Benefit Pension Schemes and regularly speaks on the topic on Radio and in Newsprint.