If you have a Defined Benefit (DB) Pension then you might have been offered the option to transfer this into the more common type of pension (Defined Contribution). This is called a Defined Benefit transfer. This is a big decision and an irreversible one, so it’s important to understand exactly what this means, and what the pros and cons might be.
As a qualified actuary and someone who has been providing Irish private pension advice to clients in Ireland for over a decade I can help steer you in the right direction.
In this article we will explain some of the key details, explain why this transfer is more attractive than ever and also explain the downsides to consider. If after reading you have an interest in exploring a transfer further I’ll point you in the right direction.
What is a Final Salary/Defined Benefit Irish private pension scheme? Advice
A defined benefit or DB Pension (also known as final salary pension) is a type of workplace pension. Instead of building up a pension pot over time, it provides you with a guaranteed annual income for life, based on your final or average salary.
DB pensions are most often provided by the public sector and government employers. Some private sector employers do still offer them yet many the private sector schemes have ceased accruing benefits for future service. A DB Pension is sometimes seen as the most attractive pension arrangement for employees. Read on for Irish private pension advice on the pro’s and con’s of transfers.
What are the Key Benefits of a DB Irish private pension? Advice
DB pensions are often seen as more generous, because it would take an above average defined contribution (DC) pot to be able to pay the same regular amount.
What’s more, the payouts from a DB pension is guaranteed for the rest of your life. So long as the pension scheme remains funded, your pension income is paid no matter how long you live. There is also a spouses pension in the event of death.
What are the key Drawbacks of a Defined Benefit Irish private pension? Advice
Despite the attractions of a DB pension, in some ways it is not as flexible as a DC pension pot. You can’t vary the income you take from it, or draw out larger lump sums (with some exceptions).
The DB pension can’t be inherited by your beneficiaries. If you die prematurely, there will be a widow’s/widower’s pension for your spouse, but most of the benefits will be lost, and nothing passes to your estate.
Also, there is also a risk that your pension scheme may collapse at some future point, if it is no longer adequately funded (e.g. employer becomes insolvent).
What is a Transfer Value for an Irish private pension? Advice
You can ‘trade in’ a DB pension for a fixed-size pot of the kind found in defined contribution (DC) pension schemes. That ‘transfer value’ is calculated to estimate the monetary amount needed to provide the same guaranteed income, based on current market conditions.
Taking a transfer value involves giving up the certainty of income for life to directly take control of the investment behind the defined benefit pension. You would then use the fund under a defined contribution arrangement to provide an income over the course of retirement.
The transfer option offers greater flexibility on how you take your benefits at the expense of certainty.
There are significant risks, in particular, investment risk with taking the transfer value and professional advice should be sought before making this decision.
The key risks in transferring to a DC pension are:
· The value is subject to investment performance, so there is risk of capital loss
· The investment performance is worse than anticipated the value might not be enough to meet your needs.
· If you live longer than you provided for.
How are transfer values calculated for an Irish private pension? Advice
The transfer value’s being offered are based on the yield on long-term government bonds. These bond yields have fallen in recent times. This has resulted in a significant increase in the transfer value being offered to pension members.
That’s why members of existing defined benefit pensions now need to reassess whether transferring the DB pension, that was once seen as untouchable, is now a realistic option.
Why are current Transfer Values at record highs for Irish private pensions?
The defined benefit transfer value is calculated under guidance from Pensions Authority and Society of Actuaries in Ireland. A factor called the Market Value Adjustment (MVA) is used to reflect economic conditions at the time of calculation.
The MVA is calculated based on an agreed measure of long -term government bond yields. The graphic below shows how this yield has changed over the past 10 years and how the MVA adjusts for it.
The table shows that as the yields fell from 3.83% in December 2010 to -0.29% in December 2020. This has resulted in an increase in the MVA over the same period from 109% to 169% (up 56%).
Source: Society of Actuaries – MVA Factor. Data from 31st October 2010 to 31st October 2020
How long will Transfer Values be at this rate for Irish private pensions? Advice
Negative yielding government debt now amounts to a record E17.2trn, the vast majority of which in the Eurozone bond markets.
This is driven by the ECB rate policy and Quantitative Easing (QE), which involves Central Banks increasing the money supply. The thinking behind these policies is to stimulate the european economy.
With QE measures in place and forward guidance implying no change in interest rates for the next 3 years, it is clear that bond yields will remain ‘captive’ to these extraordinarily low levels for some time to come.
What are the key things I need to consider before transferring my Defined Benefit pension? Advice
As well as the transfer value on offer, these are the other things you need to consider:
· Does the flexibility of the transfer value meet your requirements in retirement?
· Do I want to manage my own wealth and the investment risk that this incurs?
· Do you want to pass on your wealth to your kids?
· How secure is your current Defined Benefit scheme?
· How does the decision fit in with your other non pension assets and income?
Transferring in a nutshell, Irish private pension advice
Transfer values are at record highs due to market conditions, even if it didn’t make sense to transfer before it may do now.
Defined benefit pensions have a number of major advantages, mainly that the benefits are in theory guaranteed, but that’s not always the case.
Defined contribution pensions are generally more flexible in how you can take your benefits, but offer no guarantees on return.
Now that transfer values are relatively high the decision around transferring centres on the priority of flexibility versus certainty for your individual circumstances. That’s why it makes sense to get Irish private pension advice if your are considering a transfer.
I may be interested, where can I get further Irish private pension advice?
You should take independent qualified financial advice before deciding to transfer. This advice is usually free. If after taking advice you decide to transfer Irish private pension advisors typically receive a commission from your new pension provider.
You can check out our recommended list of Irish private pension advisors in your area here. The list only includes fully qualified financial advisors regulated by the Central Bank of Ireland.