Fiona Reddan – The Irish Times 23.05.17
Consider this. You’re 63 and are trying to decide how best to fund your retirement. You have been quoted a transfer value of €487,500 for your pension, the amount you will receive if you take the money out of your company fund and put it in your own fund.
You have two options: stay in the company defined benefit scheme, and take a €200,000 lump-sum and a pension of €15,000 a year “guaranteed”; or accept the €487,500 transfer value, put it in an approved minimum retirement fund (AMRF), and draw down a lump sum of up to a quarter of the fund – €121,750 – tax-free. Our retiree will then have €121,750 in their bank account, and with the remaining €365,750 fund, can live off the capital and draw down €14,000 a year.
So what would you do?
It’s a question that more and more people are being faced with, given that defined benefit schemes are increasingly on their way out. Indeed, figures show that there are currently fewer than 140,000 active members of defined benefit (DB) pension schemes in Ireland.
For those who remain, some will be forced into defined contribution schemes as their employers look to pull down the hatches on their DB schemes; others will be offered transfer values for schemes that may remain open, as employers look to cut the liabilities on their balance sheets.
But which is the best option? And is it a good time to transfer now?
As with many things pensions-related, the answer may appear as clear as mud at first perhaps, but here are some steps to help you make that decision.
Step 1: Know your own needs
With many decisions, it always helps to understand where you hope to end up.
“I’d encourage people to figure out what their expected household income is in retirement, and work back from that,” says John Tuohy, chief executive of Acuvest. “It helps to demystify it a little bit”.
So, for example, if you expect to need a pension income of €1,000 a month in retirement, you will be looking for a pension scheme, or a transfer value, to produce this for you – and not one that has the expectation of “heroic” investment returns, as Tuohy puts it.
Step 2: Consider what you want to happen when you die
With a DB scheme, when you die your spouse – and any dependent children – will typically be offered a spousal or children’s pension. While this is a generous element of such schemes, it will still likely result in a diminished standard of living for those you leave behind.
Typically, a spousal pension would be of the order of 50 per cent of your pension – and will this be enough to sustain your spouse?
“I’ve rarely seen household bills fall in half because one person dies,” notes Tuohy.
If, on the other hand, you look for a transfer value into an approved minimum retirement fund (AMRF) this should pass, in full, to your spouse – and it can even be passed to your children, although inheritance tax may apply.
It’s an important consideration, and one you should think about before you get into the sums of transfer values.
Joe Hanrahan, head of personal financial services with Investec, knows of clients who, faced with just such a decision, get invasive medicals before making the decision to try and ascertain how long they might live. If their health doesn’t look great, transferring out of a DB scheme may make more sense, as it protects the value of their pension for those they leave behind.
Step 3: Is the transfer value attractive?
Transfer values are calculated in accordance with statutory guidance by the Society of Actuaries – but working out whether it represents a good deal to you or not, is a little trickier.
“The essential question you’re asking is: ‘Do you take a transfer value or do you take future promise of an income for the rest of your life which may build in a spousal pension?’” says Hanrahan.
In essence, it’s about working out the value that fairly reflects what you’re giving up by exiting the scheme.
“You’ve got to ask yourself, ‘if I take it today and if I were to invest it, approximately what value of a pension is it likely to be’,” says Hanrahan, adding: “So you’ve got to make sure that the transfer value is fair; is reflective of where the scheme is at; and whether or not there’s any scope for an enhancement.”
But in general, a standard transfer value may not be enough to excite.
“The simple fact of the matter is that it represents an OK value for people close to retirement – but very poor for people far from retirement,” says Tuohy, as the younger you are, the lower the transfer value is going to be.
To make it more attractive for people, a company may decide to sweeten the deal by offering you a generous transfer value in order to get the pension off its books.
If you haven’t been offered an enhancement, you can always ask your company about the possibility of this, but Tuohy hasn’t seen negotiations of this sort in practice.
“To be honest I haven’t,” he says.
You should also consider the impact of interest rates; at present they are at historic lows, which means companies have to carry pension schemes at a higher value on their balance sheets. This means that they might be more of a mind to give you an enhanced value now.
As interest rates start to rise however, the cost of carrying pension liabilities will fall – which might make paying out cash in a transfer value more expensive.
“If a consumer wants to do it, I’d want them to do it now,” says Tuohy.
Step 4: Get advice
Whether it’s advice from a financial planner or an actuary, you will need some help in making your decision.
“Help me understand. Do I have to win at Cheltenham in order for this to be enough,” says Tuohy of what you need to be asking.
Consider also what the advisor has to benefit from you transferring your pension.
“It suits a lot of financial advisers potentially to tell clients to take the transfer value, as it goes into a product that they will be paid on,” says Hanrahan.
You will also need time; Tuohy recommends taking about three months to consider the options.
Step 5: Weigh up the risks
Whichever decision you make, there is a risk involved.
“There are risks on both sides,” says Tuohy, noting that if you opt for a transfer value and take your money now, you run the risk of running out of money or making poor investment decisions. The longer you live, the greater the risk of running low on funds.
So the guaranteed income a DB scheme offers can be attractive.
“For some people, a big amount of money would scare them. They would simply prefer €1,000 a month coming in – they understand a transfer value could be a good price but they just don’t feel comfortable with that,” says Tuohy.
On the other side, if you opt to stay in a DB scheme at the age of 45, you’ll have 20 years to retirement, and potentially another 20 years in retirement.
“You’ll be hoping nothing goes wrong with that scheme,” says Tuohy.
The risk of course is that by staying in the scheme, it ends up being wound up, or your benefits are diminished significantly.
And as the experience of Waterford Crystal, and more recently Independent News & Media, has shown us, pension schemes do and can cut benefits.
Moreover, the upside in a DB scheme which is closed to future accrual is limited; by taking your funds now and investing them, you do stand the chance of a potentially significantly better outcome.
“What type of investor you are is also a factor here,” says Hanrahan, noting that somebody who is an extremely risk-averse investor and whose ability to grow investments is limited, may be better off sticking with the company scheme.
“It may be a moot point as to whether or not taking the transfer value is a good idea,” he advises.
With an AMRF, there is a mandatory taxable drawdown of 4 per cent a year – so to keep your fund intact you will need your investments to return more than that to cover the costs of charges as well.
“The challenge for that individual is to try and sustain a return of 4 per cent plus costs in order to keep that level of income similar with the DB,” says Hanrahan.
Step 6: Make your decision
Once you have done your research and gotten your advice, you should be in a better position to make your decision.
But it won’t always come down to the figures.
“I tend to find it’s a multiple of elements that will decide it for an individual; some elements are not necessarily all financial either ,” says Hanrahan.
Indeed for some people, it’s all about having ownership.
“Taking control of your own pension fund – for some people that can be hugely important,” says Hanrahan.
This article was published in the Irish Times by Fiona Reddan on the 23rd of May, 2017. John Tuohy, chief executive of Acuvest is a contributing expert in the piece. Follow John on Twitter @jtuohy_acuvest