The Transfer Market
Defined Benefit (DB) schemes are becoming increasingly rare outside the Public Sector with a mere 600 in existence in Ireland. The main benefits of a DB scheme over a Defined Contribution (DC) scheme for employees is the promise of a fixed income in retirement, based on final earnings.
However, that promise cannot always be fulfilled. According to actuarial figures from 2017, as many as one in four DB plans in Ireland is underfunded — if wound up today, these schemes would be unable to meet their financial obligations.
This is why so many employees are being invited to “transfer” out of their DB pension scheme. If you are one of them, then seeking impartial, expert advice is essential as there are many important factors to consider before making your decision. These include —
PERFORMANCE OF SCHEME
If your DB scheme is not fully funded, this will affect the standard transfer value of your pension because your projected retirement benefit will be smaller. Remember, even if your scheme is fully funded at present, it might not remain so in the future (and vice versa).
The value of your DB pension can be calculated in different ways (one example is the DC SORP basis — Defined Contribution Statement of Reasonable Projection) to arrive at a Standard Transfer Value (STV).
In general, this value is unlikely to match the cost of purchasing the same pension benefit in a DC scheme so you may be offered an Enhanced Transfer Value (ETV).
ETVs (also known as uplifted transfer values) require careful analysis. Capitalised values can appear generous at face value, but you must consider the future cost of purchasing a benefit equivalent to your projected DB annuity. What happens if you live to be 90? Increased longevity is one of the reasons why a DB scheme is so expensive for employers.
Some ETVs are more generous than others. A key factor in deciding whether to move out of a DB scheme is the so-called hurdle rate. This refers to the gap between the investment rate the Transfer Value must earn in a DC scheme to give you the same value as your former DB pension.
Transferring from a DB into a DC scheme can offer additional flexibility. While DB schemes only offer the option of an annual pension and/or a lump sum at retirement, in a DC scheme, you have more options, including:
— ability to access your pension at the age of 50 (if you have left employment)
— a possible higher tax-free lump sum
— more power over how your pension is invested
— removal of risk caused by DB scheme being wound up
— more flexibility in what happens to your pension after you die
It is vital to obtain expert financial advice before making a decision to transfer out of a DB scheme as it cannot be reversed. Review all your options carefully with an independent advisor before signing on any dotted line.