Welcome to Informed Decisions, Ireland's #1 Personal Finance Blog & Podcast! Hope you managed to catch last weeks' Podcast with Andy Agathangelou, all about developing more transparency in Financial Services, it was a decent chat!
This week I am on a mission to shred some myths about that big question: Should I take my benefits out of my Defined Benefit pension scheme, or leave my benefits in my Defined Benefit pension scheme. Granted it is not a question that everyone of us will need to answer over a life-time but it is one that I see more and more in recent times. In addition to that it is a decision which can potentially have such a significant impact on one's future lifestyle and financial well-being that it deserves a closer inspection! Given that in the region of 60% of people who have a Defined Benefit scheme have left that employment and so will typically have the option to leave if they want. We're gonna try help them understand whether that's a wise move or not!
Before we begin I have to declare a bit of a bias I have on this topic......I firmly believe that generally speaking a Defined Benefit scheme is a hugely valuable benefit to hold onto for dear life, that you'd have rocks in your head to leave it, that it represents better value than you could possibly hope to achieve if you transferred your benefits out of it, that it will sustain you in retirement, and go a long way potentially to sustaining your partner if they survive you, that thousands of others would give their left and/or right arm to have the preserved benefit that you have, and that it is usually a case that your advisor may be steering you to leave because it will benefit them more than if you stay......but hey I could be totally and utterly misplaced in my bias. I'm just outlining that I do have a bias, and a belief that in most circumstances you'd want to have rocks in your head to take a transfer! Let's see if I'm way off or way on....
What Is A Defined Benefit Pension?
In simple terms a Defined Benefit pension scheme is one in which you are 'guaranteed' a certain level of income in retirement, based on your salary at time of leaving employment, and the number of years you were a member of that scheme. Traditionally they have been the Rolls-Royce of pensions, offering great security, value and certainty of income to retiring employees. In recent years their reputation has been tainted with swathes of employers 'closing' their DB schemes, due for no other reason than they are hugely expensive for employers to provide. Defined Contribution schemes, where the employer will make a certain payment each month on your behalf are far more manageable for employers, and usually less effective for retiring employees.
When Can I Take A Transfer Value From My Defined Benefit Scheme?
There are two main circumstances in which you may have the option to 'transfer out' your DB benefit. In essence this is where you forfeit the promise of an annual income in the future from the scheme, for a lump sum 'transfer value' now. You will be given the option the transfer out if you leave a company in which you were a member of the DB scheme, or if the scheme is being 'wound-up', i.e, the company and trustees are closing the Defined Benefit scheme and you now must move the transfer value. Depending on your circumstances you can move your transfer value to a Personal Retirement Bond, (PRB) which is sometimes also known as a Buy-Out-Bond. Alternatively you may be able to move to a PRSA or a new employers scheme, depending on the circumstances. It is probably worth noting also that you may or may not be eligible for what they call an 'enhanced transfer value' which is basically an incentive offered by the scheme to get rid of you and the expense that you and your cosy Defined Benefit represent to them!
The Potential Benefits Of Staying In A DB Scheme:
You will receive a set income for life once you retire from the scheme
That income will likely increase each year by the lower of 4% or Consumer Price Inflation (CPI)
If your spouse survives you they'll usually get 50% of the income you were getting
That income will last as long as you last!
You pay no fees or costs for the management of the scheme/funds
If bond or equity markets decline your income/benefits won't decline - employer holds that risk
You don't need to worry about managing the fund, or meeting advisors to figure out the best strategy to draw down your income - scheme does it all
Once you have retired and are drawing benefits or are a 'deferred member' 50% of your benefit, at a minimum is protected and assured by the government
If you decided to transfer at a later date you may get more than what is being offered at the moment
The Potential Cons Of Staying In A DB Scheme:
If you decided to transfer at a later date you may get less than what is being offered at the moment!
Your income could fall by up to 50% if markets declined or the scheme solvency forced trustees to reduce the benefit in future
You may live long enough to only draw a small level of income from the scheme, in comparison to the transfer value being offered
If you die and are survived by a spouse they may get some benefit from the scheme. If you have no spouse at that time then there is no other benefit payable to your estate, there is no fund value or lump sum payable to your estate.
The Potential Benefits Of Leaving A Defined Benefit Scheme?
On your death there may well be a considerable value payable to surviving spouse or your estate
You can potentially invest in property/equities/index funds/Bonds or whichever portfolio you wish via with your own Personal Retirement Bond, PRSA or Approved Retirement Fund (ARF)
You control, within revenue rules, how and when you access your pension benefits which can often help doing it in a tax efficient way
You may get the option to take your benefits at an earlier age than had you stayed in the scheme, from as early as 50 if you leave the scheme (need to be careful not to blow it all too early obviously!)
The Potential Cons Of Leaving A DB Scheme:
You will need to figure out how to invest and manage and draw-down your benefits, which even with the assistance of an experienced advisor can be tricky to do effectively
You may get less income than had you left it in the DB scheme
The funding position of your DB scheme may improve over time and future transfer value could be higher in future
If you moved to say an Approved Retirement Fund (ARF) you will be taxed as if taking 4% or 5% income per year, even if you do not need that income
You will need to pay the advice/fund fees on a new scheme
If you invest your transfer value in volatile assets (Equities/Bonds/Property) then you may have the additional concern of rising and falling values which could impact on your levels of income received in retirement. As The Clash said 'one day it's fine and next it's black'!
Should I Stay Or Should I Go Now??
So come on just let me know, should I stay or should I go......well I'm afraid that I don't have a hard and fast answer for that question, and anyone that definitively tells you one way or the other is most likely not telling you the full picture! I do still believe that the purpose of a pension is to give you an income in retirement, and the vast majority of DB schemes will do that effectively for many thousands of people in the years ahead. They are not perfect, they are a little flawed and some are in precarious positions.
Based on my own experience I do believe that the right answer will be arrived at if you consider what your priorities are with regards your retirement income and whether you have an interest in managing your own destiny, or are more content in having the minimum of fuss or maximum certainty!
At the end of the day it may be a case of 'If I go, there will be trouble, And if I stay it will be double' or it could be the polar opposite!
Thanks for reading!
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Paddy Delaney QFA | RPA | APA | Qualified Coach