Should You Transfer Your Defined Benefit Pension Value?
Defined Benefit Pension (DB) schemes are dying out. With the number of DB schemes in Ireland dropping from 2,500 in the early 90s to just above 550 now, it’s no wonder that this steep decline has been making headlines in recent years.
As more companies review their future commitments to their existing DB scheme and offer employees alternative plans, one of the questions that we find ourselves getting asked regularly is ‘should I transfer my DB value?’
As with most pension matters, there’s no one-size-fits-all answer to the question. In this article, we’ll examine some of the main advantages and drawbacks of transferring a defined benefit value into a new scheme.
But first, let’s give a better understanding of a Defined Benefit scheme, and why it’s such a unique pension plan.
What is a Defined Benefit Pension Scheme?
In short, a defined benefit scheme is one that promises to provide members with a pension from retirement until death, calculated by the number of years in service and an employee’s final salary. This type of scheme was popular amongst Irish banks and multinationals for decades, thanks to its mutual benefit to employers and employees alike. For instance, professionals would receive two-thirds of their salary following 40 years in service. This assurance of a consistent retirement income fuelled loyalty amongst employees. However, in recent years, the combination of economic turbulence and an increase in life expectancy has meant that it’s become far more challenging for employers to ‘come good’ on their pension promise.
Promise being the operative word, here. Not a 100% guarantee. As a result, many companies who had participated in the scheme no longer offered it to new employees and have given existing members the option to move to a defined contribution arrangement.
So if you’re an active (still in employment) or a deferred (an ex-employee) member of a DB scheme, and need to decide whether you should transfer your defined benefit value into an alternative scheme, you’ll need to weigh up your options.
Reasons to transfer to a new scheme:
Flexibility – alternative schemes often offer more flexibility in terms of what age your pension becomes payable. Depending on your own retirement goals, this might be a better option than having to wait until you reach normal pension age to draw down.
Tax-free lump sum – what a DB scheme might offer in terms of a consistent income from retirement to death, it can lack in tax benefits – namely allowing you to take a tax-free lump sum. With alternative schemes, members can typically withdraw 25% (or up to €200,000) tax-free, as well as a further €300,000 at the standard income tax rate (20%).
Family situation – while a DB pension scheme will pay 50% of the fund to a spouse following death in retirement. However, this benefit doesn’t tend to extend to dependents. Other pension schemes can be more inclusive in terms of how dependents are viewed and what tax entitlements are available to them.
Enhanced transfer value – if you’re being offered an enhanced transfer value on your DB, it’s worth determining the hurdle rate before dismissing it as an incentive to leave a more prosperous scheme. Calculating hurdle rate involves taking the assumed growth from investment on your transfer value to determine whether or not you will receive the same level of benefit as you would in a DB scheme.
Employer volatility – this one goes back to the fact that a DB scheme is based on a promise rather than a guarantee. In the event that the employer that funds your DB pension scheme goes bankrupt, you may stand to lose 10% of your pension fund (under retirement age).
Reasons to stay in a DB scheme:
Consistency – as a DB scheme promises to provide regular payments from retirement to death, you don’t have the same longevity risk as you would with a defined contribution pension scheme. Essentially your pension pot won’t run out if you live longer than expected.
Reduced risk – it’s ultimately the responsibility of the sponsor of a DB scheme to payout to its members, so the investment risk is completely different to that of a defined contribution pension where the stock market heavily impacts the value of your fund. That being said, the members of a DC scheme do have choices in terms of where their money is being invested.
Inflation – while inflation can put pressure on some pension funds, a defined benefit scheme has a measure of built-in protection against this. Income in retirement in a DB scheme is calculated using your final salary, years in employment and is in line with inflation, regardless of the fund’s performance.
Remaining in a defined benefit scheme or transferring your DB value into an alternative scheme is a deeply personal decision. Context really comes into play too – for example, a person that’s an active member and just 2 years from retirement will have completely different considerations to make than someone in their 40s who is a deferred member of a DB scheme.
While each situation is unique, something that can be applied to everyone is this – before making any decisions when it comes to your pension, you should seek the advice of a qualified financial advisor.
Want to talk to us about your DB pension options? Book a free 1:1 consultation now.