Most 'normal people' out there (with the exception of financial nerds & indeed yours truly until I started working in this area 12 years ago!) have no more interest in Defined Benefit and Defined Contribution schemes than the man on the moon! It's sort of like saying to your mate, 'you know, the price of beef in Kilkenny Mart today jumped from €3.60 per kilo to €4.05 per kilo in the space of an hour!!', not really that interesting or relevant to most of us, unless of course your mate is a beef farmer! If you know of anyone who losing or has lost their DB scheme please do them a favour and pass this on.
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The reality is that there are more and more instances of people facing the issue of their long-planned-for retirement dream disappear in a puff of smoke when their employer announces that due to cost constraints they 'have no other option' but to close the Define Benefit (DB) Scheme and offer them a Defined Contribution (DC) Scheme instead (as we saw in an earlier blog)
It's all great and wonderful when we are in a DB scheme, things look fine, we have our 'guaranteed' retirement income locked in, however when that changes, when we are suddenly told that our DB benefits are no longer what we had hoped, it is a big concern. As with all things it is probably best dealt with by assessing the impact for you personally, looking at the options objectively and then determine the best means to proceed. Firstly lets look at why so many DB schemes are closing or winding-up.
Why Did My Defined Benefit Scheme Close?
While there is no benefit to be had from 'sifting through the rubble' it's useful to have context on why many DB schemes are closing.
Bottom line is that they are so expensive to maintain, from an employer perspective. Like an 'open cheque'. E.G employer contribution may need to go from 15% of the wage bill to 30% to remain funded and viable, for now! If you have 1000 employees, with an average wage of €60k, that's upping your contribution from €9m this year to €18m next year, with no guarantee that it will solve the problem long term, that's just to plug the gap for now!
If the scheme is what they call 'in deficit', as in not enough to pay the pensions due up to this point & never mind the future pensions of current employees, then the benefit you have built up could be in jeopardy. Not to ever scare-monger but this is what happened in Waterford Crystal, where the DB scheme was so far in deficit that most workers' pension benefits were unable to be met. Eventually the State stepped in with Joan Burton & Unions doing a deal of €180m in 2015 to help those who were left with their cap in their hand....
As well as that, from an employers perspective if the scheme is in deficit it shows as a liability on the company Balance Sheet. Not good from a shareholder perspective! However if they wind it the scheme that deficit no longer appears on Balance Sheet!
Impact of Annuity Rates:
To give some idea of the costs of funding an income in retirement (separate blog on this one soon!) here is a look at now versus 30-odd years ago.
Let's say you were a big-shot employer in 1980, sat in your big leather swivel chair, smoking your cigar and supping brandy at elevenses!! You have a retirement pot of equivalent of €100k for each of your employees. You could get approx €13,000 per year for each employee with that €100k, based on annuity rates back then. (annual pension income you can buy for a given lump sum). That's an annuity rate of 13%!
Now imagine you are a big-shot employer in 2017, sat in your bean bag in tatty jeans and t-shirt with your big beard (this is the male version!) and your cold-pressed americano at 6am in Grand Canal Dock! You also have €100k for each of your employees. How much of a pension income can you get for each of them based on today's annuity rates? Approx €4k per year, that's less than €340 per month!
So what's the point? You need approx three time the funds to give the equivalent pension as you could give 30-odd years ago! The costs have tripled because annuity rates have plummeted (which are linked to long term German Bond yields- I know I know I'm getting technical sorry!).
Ok, so enough about all that 'sifting through the rubble', where does it leave me and what can I do about it!?
Where does it leave me?
With regards to your Defined Benefit service you have 1/60th for every year 'banked' (we are assuming here that the scheme is not 'winding up' entirely, just closing). You have your slice of cake earned from those years served under DB parked in the tin until retirement.
Your employer may be relieved to press 'pause' on that DB scheme because as we said it is an 'open cheque' for them but they do want to ensure you can provide for yourself in retirement so now you can move forward with a Defined Contribution Scheme for future benefits. This is known as a 'hybrid scheme' whereby the DB is parked and the DC runs from now-on.
Typically an employer would offer to pay approx 5 - 15% of your salary into this scheme and allowing you to pay another 5-10%, equating to approx 20% of your salary into the DC Scheme. Your options are to contribute, not to contribute, or contribute more!
What Pension Incomes Could I Have Now?
A. State Pension: If you are looking at your projections under the new scheme it may well state an amount per year of €12k from the state contributory pension. Is this guaranteed? We all know that there is potentially going to be amendments made to the level of State Pension by the time we get to claim it. However, as of today that is what it is. Best to have a back-up plan? Probably a prudent approach yes!
B. Your Deferred DB: For example if your salary is €70k and you have 15 years service in the scheme your projection statement may well state that you have a 'preserved DB benefit' in the region of €17k per annum (15/60ths * 70,000) waiting for you when you get to retirement age under the Defined Benefit Scheme.It may even go as far as to state that this annual benefit will increase in line with inflation/Consumer Price Index, so as to protect the future value for you.
Is this €17k guaranteed? Ultimately it is not. Again this benefit is dependent on the fund remaining 'funded' and in a healthy state. If it did come to a situation where-by the fund could not meet it's liabilities (pensions payable) then the order of priority as set out by regulation is the following:
- Pensioners get first priority (those who have retired out of the scheme)
- Leavers get next priority (people who have left the company and left their deferred pension benefit in the scheme)
- Existing employees get last priority.....ouch!
The fact that the fund is now closed should improve the chances that your benefit will be there for you to collect when you get to 'the finish line', and minimise the chances of another 'Waterford Crystal'.
C. The New Defined Contribution Scheme: One of the positive things about the DC scheme is that whatever is in your DC pot is yours. Unlike the DB scheme which is all one big pot shared out among all (and 'diveed' out as above!) however your DC funds are your funds, nobody can claim ownership other than you!
Draw-backs? Yes, the value will rise and fall as per the funds you invest in and you have no idea what annuity rates will be when you get to retirement if you decided to go that route.
One of the great things about DC route with having a preserved DB is that you should have access to doing an ARF (your own cake-tin) which brings with it many benefits.
D. AVC. You may decide to put more than 20% into your pension, if you have the means and the fore-sight! If you are in your 30's the max you can personally contribute and get tax relief on is 20% of your income (based on max income €115k), rising to 25% in your 40's and 30% for 50-54, 35% for 55-59 and 40% for 60's and over. Irrespective of whether you do the AVC's under the employer's scheme or not, and you have the DB benefit (to bring your retirement income over 12,700 per year) you should have access to either using the AVC funds to buy an annuity, tax taxable cash lump sum, or the avail of the ARF (your own cake tin!).
E. Other! You may decide that rather than focus on pumping money into pensions that you will invest directly, buy property, invest in Employment & Investment Incentive Scheme, or whatever might float your boat! Irrespective of what route you take a plan is always a good thing!
I have real empathy for you if you are in the situation above, it is worrying and it's a fairly complex situation to get one's head around. The aim of this piece was to give you some headlines and clarity on what lies ahead. However if your scheme is closing and not winding up you do not have to deal with the head-ache of what to do in that situation, transferring your pension benefit from DB scheme to Buy-Out-Bond, PRSA or other scheme......this is a real mine field, be thankful you're not faced with that!
As per the title of Ryan Holiday's inspiring book 'The obstacle is the way'.....it's done, you cannot change that, acquiesce to the changes and make a new plan, and make sure it is an informed plan!
Thanks for reading, please help us spread the word by sharing this with friends and colleagues.
QFA | RPA | Coach
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