Should you transfer from a defined benefit pension?

[Marc]

Should you transfer from a defined benefit (also known as final salary) pension?


The UK’s financial regulator has reversed plans to loosen pension transfer rules after finding a “significant proportion” of savers were wrongly advised to give up guaranteed retirement benefits.


The Financial Conduct Authority last year proposed changes that would have made it easier for pensions advisers to advise clients to transfer their defined benefit pensions, which promise an assured retirement income, in return for a cash lump sum.


Currently advisers in the UK must start from the position that the transfers are not appropriate for most clients.


What I find most interesting about this story is that all transfers above a de-minimus amount in the UK must be referred to a pension transfer specialist.


Yet, still there is widespread evidence of mis-selling such as in the recent case of British steel or at least poorly documented advice.


From the FCA paper CP18/7


“In October 2017, we published the findings of our supervisory work on pension transfer advice, looking at transfers from DB to DC schemes. In the files we reviewed, we found that only 47% of advice to transfer from a DB to a DC scheme could be shown to be suitable. In addition, only 35% of the products and funds recommended for the new scheme were deemed suitable. As a result of our work, a number of firms have voluntarily varied their permissions and have stopped advising on pension transfers”

So, the UK applies a rules-based system of regulation and these rules are especially strict in relation to transfers from defined benefit schemes.

In Ireland the regulation is "principles-based" rather than rules-based.

There is no requirement for Irish advisers to take specialist pension transfer qualifications. I have been advising in Ireland for the last 10 years and I have not been required to sit any additional specialist examinations beyond the minimum competency qualification the QFA although I do hold specialist examinations from the chartered insurance institute in the UK.

I haven't conducted a widespread study by any means but the last pension transfer report I reviewed from a well-known Irish employee benefit consultancy fell well short of the UK standard of advice.

I suppose as a consumer I'd prefer to know that advisers were trained specifically to be competent to deal with complex advice with expectations set by the regulator and against which poor advice might be judged rather than a system of "let's hope they do a good job".

With this in mind I will write a more detailed post setting out a triage service for those considering if they should :


Take a transfer from a deferred defined benefit pension;

The issues to consider when leaving/having left Ireland with a retained benefit in an Irish defined benefit scheme;

How to seek advice when a scheme is winding up or if you receive an offer from the trustees of an enhanced transfer value

 

[WhiteCoat]

Hi Marc,

I have a deferred pension from the UK. I always understood that unless special circumstances applied (e.g. poor health, etc.) that it was a no-brainer in terms of risk/reward just to leave my pension where it is. At a high level, do you concur?

I must admit finding your post a little confusing. On the one hand, you record the dismal performance of UK advisers and then you say that what you've seen recently from Irish advisers does not match UK standards?

 

[Brendan Burgess]

Hi Marc

That is an excellent idea. What happened to British Steel employees appears to be a disgrace although it's not clear to me if their losses are due to the changes in the pension scheme or the vulture advisors who exploited them.

Would the following title to your thread be appropriate...

"You should not transfer from a Defined Benefit Pension Scheme unless..."

I think that the bar should be fairly high.

Brendan

 

[Palerider]

I would not give up my defined benefit scheme no matter what I was presented with, protections are terrific since the Waterford Crystal workers case was successful.

There will be ups and downs in the markets but the defined schemes once funded keep on delivering an income that for many is their only source of fixed income in retirement, not to be messed with except in the most extraordinary of circumstances.

 

[Clamball]

Our company proposed earlier this year to close our DB pension scheme and transfer us to a DC pension scheme. We have a choice of taking an ETV of our pot from the DB scheme and transferring it to the DC scheme or of leaving the DB scheme as it is and starting in the DC scheme with zero.

They got one set of independent consultants to tell us what was proposed and then another set of consultants to give independent financial advice to each member based on their individual financial statement. It was extremely stressful, I read everything I could and eventually decided that the best for me was to stick with the pot I have in the DB scheme. Luckily the advisor advised me the same way, said it was a no brained. Now all I have to worry about is if the DB fund will remain fully funded for the rest of my life.

My boss however could not wait to get the ETV and get the funds out of the DB scheme and into a DC scheme.

 

[jpd]

The DB scheme trustees should keep you up to date on the status of the DB fund annually, at least. Obviously, if the fund is closed, then it's performance will depend on the investments it makes with the fund monies. If you are so minded, you can look at becoming a trustee of the fund - after suitable training and education - and help in ensuring that the fund is been run in a prudent manner for the benefit of its members. The company may also have guaranteed to fund any shortfall or part thereof.

 

[Steven Barrett]

With the actuarial methods for calculating a transfer value of a DB scheme out of kilter with reality, staying in the DB scheme should always be the starting point. But the solvency of the DB schemes is always the big issue then and you should always get a copy of the annual and actuarial report to see what the employers intentions are for the scheme.

A lot of people prefer the option of the ARF and with it a potentially higher tax free lump sum. But you are then giving away all guarantees and taking on all the risk and costs yourself.



Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[WhiteCoat]

Hi Steven,

Thanks for your post which confirms what I had broadly understood, admittedly, at a high level. In order to understand better the dynamics at play here, I wonder if you could help me with some elements that you addressed in your post.

Firstly, you mention the actuarial methods. What I'd like to know is in what way is the calculation out of kilter with reality and why is in not put back in kilter? In other words, how bad is the methodology, who decides on it and what is the justification?

My second question is about the point you make about the solvency of the plan. I'm taking this to equate to the likelihood of the member actually receiving his pension. What I'd like to know is what safeguards are in place to protect members?

My final question(s) relate(s) to the previous two and I know that this is an Irish site. That said, I think it would be interesting to compare the Irish approach with international best practice. For example, how are transfer values calculated in other countries (i.e. how would the transfer payments compare?) and how are the benefits of members protected, etc? (I'm asking this not just because my own deferred pension is in the UK!).

 

[jpd]

I am now receiving a pension from a company pension scheme in the UK where I worked for 10 years up to 1983.

I read the annual reports and actuarial reports every year which was always a great way to understand how the fund was going. The company agreed to cover the shortfall by making payments over a period of year after the scheme was closed. This was a major factor in deciding to stay with the scheme rather transfer out. I also had worked with some of the pension trustees and had confidence in their ability to manage the scheme in the interests of the members.

You have to take an interest in the scheme and try to understand the finances - I am sure that most scheme trustees are only too happy to answer your questions and explain what they are trying to achieve

 

[Steven Barrett]

Firstly, you mention the actuarial methods. What I'd like to know is in what way is the calculation out of kilter with reality and why is in not put back in kilter? In other words, how bad is the methodology, who decides on it and what is the justification?

I've written about this previously . I've copied and pasted the assumptions used:

1. There is a discount rate of 7% applied to your benefit. That means that for your transfer value to meet their valuation, your fund has to grow by 7% net EVERY year to retirement. That's pretty difficult to do and would require a lot of risk and a bit of luck.
2. The post retirement discount rate is 4.5%. With annuities linked to long bonds, this is another tall order.
3. Inflation is calculated at 2%.
4. If the scheme is underfunded, your transfer value is reduced accordingly. It would be unfair for members to be able to take 100% of their transfer value, leaving the active members to fund an ever increasing deficit.

The assumptions are agreed with by the Society of Actuaries. Maybe one of the actuaries who posts on here can clarify why such assumptions are used. A guess would be to reduce the cost of transfer values.

My second question is about the point you make about the solvency of the plan. I'm taking this to equate to the likelihood of the member actually receiving his pension. What I'd like to know is what safeguards are in place to protect members?

My final question(s) relate(s) to the previous two and I know that this is an Irish site. That said, I think it would be interesting to compare the Irish approach with international best practice. For example, how are transfer values calculated in other countries (i.e. how would the transfer payments compare?) and how are the benefits of members protected, etc? (I'm asking this not just because my own deferred pension is in the UK!).

Again, copied and pasted from a previous article

Both defined benefit scheme and employer is insolvent

1. 50% of the pension is protected for both pensioners and active and deferred members. Those on pensions of €12,000 or less are guaranteed 100% of their pension (Old Age Pension is additional).
2. If there is anything left, the pensioners have their annuity topped up to 100%.
3. Current/ deferred members have their benefits topped up from whatever (if anything) is left.
4. If there is not enough money to cover the 50% minimum protection level (or 100% of pension is less than €12,000), the government will pay for it from the pension levy.

Defined Benefit Scheme is insolvent but employer is not

1. Pensioners receiving pensions of less than €12,000 are prioritised and get 100% of their pension.
2. Pensioners who receive between €12,000 and €60,000 receive 90% of benefits.
3. Pensions who receive over €60,000 receive 80% of benefits.
4. Once the retirees have been paid, the current/ deferred members receive 50% of benefits.
5. If there is anything left at this stage, pensioners get their annuities topped up and then current/deferred members
6. As the company is still trading, there is no government funding in this situation.
7. The same type of structure applies in the situation where the pension scheme is being restructured.

There are certainly more protections in place for those who have yet to receive their benefits. In the past, there were ranked so far down the list, they got little if anything after everyone else was looked after.


Can't help you on the international protections.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[WhiteCoat]

Thank you Steven,

Me again! I'm indulging in a day's goofing & surfing before heading back to work again tomorrow. I really enjoy trying to figure out financial questions so thanks for patiently bearing with me. I'm always amazed how generous subject matter experts are with their time on Askaboutmoney.

The assumptions are agreed with by the Society of Actuaries. Maybe one of the actuaries who posts on here can clarify why such assumptions are used. A guess would be to reduce the cost of transfer values.

I don't really get this bit. What is the purpose of the transfer value calculation? In setting out the methodology, what are the actuaries trying to achieve? Why would they be attempting to keep the transfer values low? Is the transfer value calculation approved by the Regulator?

Both defined benefit scheme and employer is insolvent

If there is not enough money to cover the 50% minimum protection level (or 100% of pension is less than €12,000), the government will pay for it from the pension levy.

I hadn't realised that the levy was still in play for company plans. Is it in a ring-fenced fund?



Finally, are you saying that if the scheme is insolvent but the employer is not then the employer can just walk away from the shortfall in the fund? That seems unfair on members.

 

[JoeRoberts]

[QUOTE
The assumptions are agreed with by the Society of Actuaries. Maybe one of the actuaries who posts on here can clarify why such assumptions are used. A guess would be to reduce the cost of transfer values.

[/QUOTE]

I'm not an actuary but my understanding is that the discount rates for calculation of transfer values are set by the Dept. of Social Protection and then incorporated into the actuaries guidelines. There has been some reduction in recent years, I think pre-retirement rate is closer to 6% now. Still way too high of course.

A number of schemes closed in Ireland in the recent past where the rate used was actually negative, i.e. it approximated to the cost of buying a deferred annuity. This should be the starting point for Trustees to negotiate pension transfers but few have the guts or knowledge to do so. The Omega Pharma case makes good reading for anyone interested in this area.

https://www.williamfry.com/newsandi...2/lessons-from-the-omega-pharma-appeal-ruling

it's a pity there are not more Trustess out there doing their job properly like these guys. Most Trustees are lame ducks, following the guidance of pension administrators who are paid by the employer.

 

[Steven Barrett]

Thank you Steven,

Me again! I'm indulging in a day's goofing & surfing before heading back to work again tomorrow. I really enjoy trying to figure out financial questions so thanks for patiently bearing with me. I'm always amazed how generous subject matter experts are with their time on Askaboutmoney.

I don't really get this bit. What is the purpose of the transfer value calculation? In setting out the methodology, what are the actuaries trying to achieve? Why would they be attempting to keep the transfer values low? Is the transfer value calculation approved by the Regulator?

I hadn't realised that the levy was still in play for company plans. Is it in a ring-fenced fund?

Finally, are you saying that if the scheme is insolvent but the employer is not then the employer can just walk away from the shortfall in the fund? That seems unfair on members.

If you leave a DB scheme and take the value of the pension with you, an actuary has to calculate what the real value is. So if I have a guaranteed pension of €30,000, how much will they give me today instead of €30,000 for the rest of my life? They way they calculate it is what do you need today to invest, so that at retirement age, you can fund your own €30,000 a year. It is the figures they use that are unrealistic. As Joe has clarified, they still assume 6% net return.

It is in the interest of the scheme to keep the transfer figures low so the cost will be less and less people will transfer out. If they used a growth assumption of 4%, the transfer value will be higher. And people would have a more realistic chance of actually getting that return, so more will take money out. Pension schemes will get requests of huge transfers and deplete the fund.

It is all approved by the Pensions Authority.


The pension levy is not being paid anymore. It was paid for 4 years, increased and given a different name for the 5th year (Noonan then claimed he kept his promise of 4 years. Changing the name doesn't quite cut it!).

Irish governments don't ring fence anything! They told me that it was also for job creation. I asked them how many jobs they created from it? If you are going to rob billions from people's pensions and use it for job creation, you should be keeping track of the jobs being created. How else would you know it worked? It went into the general exchequer.

I had just copied and pasted that part of the blog. I've just checked the date of it, December 2013. It was blog #19. We're now at #247!


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[WhiteCoat]

An actuary has to calculate what the real value is.

They way they calculate it is what do you need today to invest, so that at retirement age, you can fund your own €30,000 a year. It is the figures they use that are unrealistic.

Hi Steven,

There are a number of points in your post that I just can't grasp.

For example, what you seem to be saying is that the actuary calculates a current value which when invested should replicate the pension that you would otherwise receive within the pension scheme and that in performing this calculation, the actuary uses unrealistic assumptions. What I don't understand is if the actuary is calculating the "real" value why does he use unrealistic assumptions?

It is all approved by the Pensions Authority.

And why would the Pensions Authority approve the use of unrealistic assumptions? Is it not their job to protect members of pension plans?

It is in the interest of the scheme to keep the transfer figures low so the cost will be less and less people will transfer out. If they used a growth assumption of 4%, the transfer value will be higher. And people would have a more realistic chance of actually getting that return, so more will take money out. Pension schemes will get requests of huge transfers and deplete the fund.

If you google pensions transfer values Ireland, there will be a lot of material about pension funds giving incentives for members to transfer out. This seems to be inconsistent with the point that you are making above?

 

[Conan]

Transferring from a DB scheme can be very complicated and the numbers can vary from scheme to scheme.
Firstly one needs to determine how well funded the scheme is. In a well funded scheme, it is likely that the transfer value will look better. In an underfunded scheme, it may be that the transfer value will be less.
If one decided not to opt for the transfer, one still needs to consider the security of the scheme going forward and whether or not the promised benefits will actually be paid in the future.
In calculating a transfer value offer, some scheme will reflect any underfunding and thus the figure offered may not be projected to provide equivalent benefits (but possibly in a DC scheme the resulting retirement lump sum might be higher and the option to invest the residual fund into an ARF might be more attractive than a fixed Annuity).
Other schemes may want to “encourage” members to take a transfer value and thus offer an “enhanced transfer value”. This might be because by reducing the funding liability in the DB scheme they are also reducing any unfunded liability which would otherwise have to be taken onto their Company Balance Sheet.
The Actuary to the Scheme, in calculating the transfer value to be offered, will take into account the views of both the Employer and Trustees.

So from the members viewpoint, they need to consider:
- do they want the (relative) security of a Defined Benefit (subject to the likelihood of the scheme remaining solvent into the distant future)
- would they prefer the flexibility of transferring into a DC scheme, which would allow them the option of either buying an Annuity or investing into an ARF on eventual retirement. The individual’s state of health might be a consideration as the DB Annuity might cease on death (unless there is an attaching Spouse’s Pension), whereas an ARF might allow for any remaining ARF fund to transfer to a spouse or children.

So this is a complicated decision and I would suggest that good professional advice is essential.

 

[Steven Barrett]

For example, what you seem to be saying is that the actuary calculates a current value which when invested should replicate the pension that you would otherwise receive within the pension scheme and that in performing this calculation, the actuary uses unrealistic assumptions. What I don't understand is if the actuary is calculating the "real" value why does he use unrealistic assumptions?

I am waiting for an actuary who posts here to explain it. I don't work in defined benefits, so maybe someone with more experience in the area can explain.

And why would the Pensions Authority approve the use of unrealistic assumptions? Is it not their job to protect members of pension plans?

They have very little power. And what they do do, is ensure that schemes are run properly and are solvent. The minimum funding levels set the bar so low that a "fully funded" defined benefit pension scheme couldn't possibly meet its liabilities.

If you google pensions transfer values Ireland, there will be a lot of material about pension funds giving incentives for members to transfer out. This seems to be inconsistent with the point that you are making above?

If the transfer value was higher, everyone would transfer out. It would cost the employer even more money and there would be a rush. The incentives offered are selective and for a limited period.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[WhiteCoat]

Thanks Conan and Steven,

I agree that it makes sense for an actuary to comment on my various questions.

 

[elacsaplau]

Hi WhiteCoat,

I'm afraid I don't really have time to answer all your questions right now. Maybe in a few days time when things settle down a bit. In the meantime, I'm posting the link to the current TV basis, as mentioned by JoeRoberts. At a high level, it's a very weak basis (not aware of any country with a weaker one). In an earlier post, Steven set out the headline assumptions of the previous TV basis, as follows:

1. There is a discount rate of 7% applied to your benefit. That means that for your transfer value to meet their valuation, your fund has to grow by 7% net EVERY year to retirement. That's pretty difficult to do and would require a lot of risk and a bit of luck.
2. The post retirement discount rate is 4.5%. With annuities linked to long bonds, this is another tall order.
3. Inflation is calculated at 2%.
4. If the scheme is underfunded, your transfer value is reduced accordingly. It would be unfair for members to be able to take 100% of their transfer value, leaving the active members to fund an ever increasing deficit.

The bit that I'd be most concerned about in Steven's description is that he seems to be unaware of the "market value adjustments" that apply to 1 and 2 above - see the guidance notes per link below. Not sure how mathematical you are but sure @dub_nerd will put a tutorial together in jig time for all users!

https://www.pensionsauthority.ie/en...tion_34_of_the_Pensions_Act_1990_Oct_2016.pdf

 

[Steven Barrett]

Hi WhiteCoat,

I'm afraid I don't really have time to answer all your questions right now. Maybe in a few days time when things settle down a bit. In the meantime, I'm posting the link to the current TV basis, as mentioned by JoeRoberts. At a high level, it's a very weak basis (not aware of any country with a weaker one). In an earlier post, Steven set out the headline assumptions of the previous TV basis, as follows:


The bit that I'd be most concerned about in Steven's description is that he seems to be unaware of the "market value adjustments" that apply to 1 and 2 above - see the guidance notes per link below. Not sure how mathematical you are but sure @dub_nerd will put a tutorial together in jig time for all users!

https://www.pensionsauthority.ie/en...tion_34_of_the_Pensions_Act_1990_Oct_2016.pdf

Elacsaplau
When I blog about a topic, I keep it general.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

 

[Bronte]

As far as I'm concerned a defined benefit is the gold standard. My husband's company moved all new staff to defined contribution and sent in top notch heavy hitting suits to 'sell' it to the existing staff. Much like this thread and others they tried to bamboozle them with reams of documentation, slides and presentation. You'd literally be brainwashed into believing black was white. This is not meant as an insult to the very knowledable posters on here. But this area is very complex to ordinary people. So my post is only to say 'watch out'.