Twist or stick on defined benefit pension buyouts?

Defined benefit (DB) pension schemes were once commonplace in the private sector and offered retirees a guaranteed predictable retirement income for life, regardless of the pension fund’s performance. Volatile financial markets, increased life expectancy, as well as greater regulatory scrutiny and balance sheet requirements, led to many schemes becoming unsustainable in recent decades.

Many of the remaining DB pension schemes in the State have been closed to new members and new accruals for several years. Some employers offer to buy out members’ DB entitlements, effectively derisking their commitment in exchange for what is known as an enhanced transfer value. In what circumstances should a member consider availing of such an offer?

Shane Prendergast, head of retirement propositions at Irish Life Employer Solutions says that understanding what makes a good offer falls into the “buyer beware” category. The value of a DB pension and the certainty of the promise it delivers is really substantial. It should never be given up without careful consideration.

“A buyout offer will always present as a big number, it might even feel like a jackpot. But it’s a big number for a reason so people need to see beyond that. In reality, buyout offers don’t typically reflect the true value of replicating your pension elsewhere. They also come with new risks.”

Firstly, he notes, you need to understand how that big number will be sustained over the course of your life, given people’s greater longevity. Then you need to do the maths, looking at the cost of replicating this certainty or income promise. There are calculators you can use for this like the Irish Life calculator pensionchoice.ie, he says.

“I’d also caution people to be wary of illustrations promising better outcomes as these only come with more risk. Ultimately, you need to decide if you’re happy to give up the certainty that comes with a DB pension – it’s hard to put a number on that peace of mind. If you take a buyout, you’re taking on the responsibility for making the money last the rest of your life. People need to be sure they’re comfortable with that.”

There are a number of circumstances where an individual member may consider a transfer value option. Transfer values are generally available as an option for any deferred member of a pension scheme, ie a former employee who has left the service of the sponsoring employer but retains benefits in their defined benefit scheme, payable from a future retirement date, says Christopher Delaney, head of risk transfer at Marsh Investments and Retirement.

“We have seen an increase in the usage of the transfer value option over recent years. The decision to exercise this option can be complicated and financially significant. Taking advice from an appropriately qualified expert will help give members peace of mind that they have considered their options carefully, whether they ultimately decide to take the transfer value.”

When companies put together an enhanced transfer value offer to their defined benefit pension scheme members, they will be seeking to make the transfer value offer attractive enough to be taken up by members while still seeking to reduce their pension costs compared to retaining the member within the scheme to retirement, explains John O’Hara, private client adviser and actuary at Davy.

“The enhanced transfer value will be calculated based on a set of reasonable assumptions for future growth and member life expectancy. Whether the offer is attractive to members will likely be driven mainly by their expectations around the level of future investment growth they could achieve on the pension value once transferred out of the scheme.”

Expert and independent technical advice will usually be offered to the member in order to assist them in analysing whether they can reasonably expect to invest the transfer value and receive a retirement income that matches or exceeds the expected DB scheme retirement pension, he says.

“This will depend on the level of the enhanced transfer value, the expected future investment growth on that value, and the member’s life expectancy. Unfortunately, only the first of these factors is known when carrying out this analysis, so it’s worth considering a variety of scenarios to understand the impact of lower investment growth and longer life expectancy on the expected benefits under the enhanced transfer option.”

Do members have the right to say no?

“Members can absolutely hold out or say no – you are under no obligation to take a buyout offer, though offers will typically be presented with a limited window. That tight window is generally driven by operational or processing timelines more than anything, but it does add to the decision pressure. People should try not to allow the short time frame negate them getting professional advice or understanding the offer in full before making their decision,” explains Prendergast.

A transfer may be attractive to some members, but it will not be the right decision for everyone, and members should consider the benefits they may be giving up, Delaney says.

Where a transfer value offer is made on a “last chance” basis at the end of a pension scheme’s lifetime, members should be aware that failing to engage with the offer may mean losing the opportunity to consider a transfer value in the future.

“This does not mean that they will lose their pension benefits. In many cases, they will retain the benefits provided under the scheme, which may subsequently be secured through an insurance policy. However, the exact position will depend on the particular scheme and transaction. Members should therefore read the transfer offer documentation carefully and establish what will happen if they do not respond or do not accept the offer.”