Defined benefit (DB) schemes, outside of the public sector, are becoming something of an endangered species in Ireland. The total number of schemes has reduced from approximately 2,500 in 1991 to circa 600 in 2015. DB schemes cost a lot and those costs can vary significantly on a regular basis – not traits favoured by many businesses.
In addition to the decision by some employers to close the entire scheme down, many employers have been chipping away at the problem by trying to entice individuals to leave the scheme. Employers are effectively offering employees a top-up, in addition to the standard transfer value, to leave the pension scheme permanently. Employers are happy because the total cost of the enhanced transfer value is still usually less than the current accounting cost or the funding cost of that benefit. Members who want to take a transfer value are happy because they get a higher transfer value. With all parties seemingly content with this outcome, it’s surprising to learn that these programmes haven’t resulted in high take-up rates.
We have written extensively about how complex a decision it can be for members weighing up two very different approaches to retirement. You need to consider expected returns, investment risks, estate planning goals, income stability, legislative protection, as well as the likelihood of the employer supporting the pension plan in future. Essentially, you could argue that members need a law degree, a finance degree and a crystal ball to weigh up the options. That said, I believe companies are making some common mistakes which have lessened their effectiveness in implementing enhanced transfer value programmes:
In the normal course of events, most members do not ask to transfer the value of their retirement benefits. Members can be apathetic about pensions, have high regard for DB benefits, or feel that the standard transfer value is low, particularly when they are younger. To make members sit up and take notice, employers need to make members a decent offer. How big that offer is will depend on the individual company itself, but if you don’t offer enough, the take-up rate will be very low and you may end up spending a lot of money in consulting and actuarial fees for little or no benefit.
Some employers have used ex-employees almost as a pilot programme. Apart from out-of date contact details making communication a challenge, benefits can be relatively small and a transfer value is then often not appropriate. In addition, the potential savings for the employer is commensurately low, while the project costs, which are driven more by the number of members, remain relatively high. It may be worth a more targeted approach such as concentrating on members approaching retirement with relatively high benefits, or members approaching the Standard Fund Threshold.
Obtaining carefully considered advice is really important for members making this difficult decision. Many programmes are rolled out with great intentions and large communication budgets. Unfortunately, despite best efforts, advice tends to be relatively generic and not tailored to individuals’ circumstances. In particular, not enough attention is paid to an individual’s entire wealth and wider lifestyle goals. This is usually due to a combination of time and budget constraints for the consultancy involved but also the level of caveats and disclosures that are required in the documentation the individuals receive. More comprehensive advice is required, particularly for executives or high earners who are likely to have other sources of wealth, to present a full picture and enable individuals to make the correct decision for them.
For the majority of individuals, the transfer value, even with a top-up, may not be appropriate – particularly for those not comfortable managing their own investments or those without other sources of income or wealth. In order to ensure members fully understand the risks involved or are not blinded by the relatively large cash value, the analysis is usually completed using very conservative assumptions. I can see the logic behind the approach but I wonder whether this is really fair analysis.
I am completely in favour of illustrating ‘stress scenarios’ like a market crash or a prolonged period of poor returns however I think there should be balance. I believe that a range of outcomes based on different returns (including positive returns) should be outlined to members. In addition, much of the analysis I have seen is based on the assumption that an individual takes a transfer value and in time goes on to purchase an annuity at retirement.The reality is that any member who favours the annuity option should not take a transfer value unless there are grave concerns about the security of the pension scheme. Therefore, the basis for all the analysis is fundamentally flawed and skewed to discourage individuals from taking a transfer value. I think we need to move to a more comprehensive but also a more balanced approach and believe that individuals are capable of making the correct decision for themselves with the help of expert advisers.
Even if you take account of all the issues outlined above, this is still a difficult decision for individuals and the right decision cannot be known without the benefit of hindsight. That said, with time, analysis and holistic advice, individuals can make a decision that’s right for them. At Davy, we have a dedicated financial planning team with actuarial, tax, financial planning and investment expertise to help individuals who have been offered enhanced transfer values. We provide comprehensive analysis and meet with individuals and their spouses to help them make the correct decisions for them and their family.
Talk to a Davy private client adviser about how we can help you on your financial journey.