Understanding enhanced transfer values of defined benefit pensions

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12Dec
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Understanding enhanced transfer values of defined benefit pensions

Due to legislation changes in June 2016 — introduced by the then finance minister Michael Noonan — it means that members of any defined benefit pension schemes now have an alternative method of accessing their pension fund.

They can now take a ‘transfer value’ in lieu of their tradition annual pension entitlement. This option is most popular with members who have left their employment, either through a redundancy package or moving employment.

The main benefit for deferred members is that they can access these funds from age 50, whereas with the traditional drawdown option, access is restricted to the normal retirement of the scheme (usually 60 or 65). The transfer value lump sum offered is usually calculated by the pension trustees of the scheme.

Some schemes offer modest transfer values, while other firms offer enhanced transfer values. Over the past couple of years there has been a significant number of corporations offering Enhanced Transfer Values (ETV’s) in an effort to entice members to take the offer. Many semi-state bodies such as eircom and An Post are offering these values to their ex-employees. Ulster bank are currently in the process of writing out to many of their ex-employees offering them very lucrative ETVs for a limited time only.

Some members have been offered up to 25 times the value of their annual pension as a lump sum. If the company pension fund is underfunded this may put significant financial strain on company profits. Pension funds are classed as a liability on each company balance sheet. This can have a negative impact on the share price or market valuation of a company. This becomes a major problem if/when a company decides to prepare itself for a potential acquisition or buyout as the pension fund could significantly decrease the net asset value of the company.

For these potential risks, many companies, particularly those that wish to prepare for an acquisition or buy-out. have started to offer enhanced transfer values to their employees and ex-employees on their individual pension pots in order to entice them to transfer out of the scheme. This in turn will decrease the company’s liability on their balance sheet and increase their potential selling price. Under current legislation, companies have the authority to significantly reduce these benefits if the overall pension fund is underfunded.

Background as to why ETVS are being offered by companies

Companies with Defined Benefit Pension schemes typically offer their employees: a tax-free lump sum paid on retirement (usually age 60 or 65). An annual pension income that is paid for the rest of their lives, on retirement. Each employee’s pension fund calculations are directly related to their final salary and their years of service.

The company is promising to pay each member a certain amount of money on retirement for every year they have worked in their business. The higher their years of service in the company, the higher their pension entitlement will be. However, this is a promise and not a guarantee. Under current legislation, companies have the authority to significantly reduce these benefits if the overall pension fund is under performing or underfunded. They can also wind up the scheme at any stage.

The employer’s risk exposure with defined benefit schemes

Over the past few years, it is very rare that companies offer defined pension packages as part of their employment to their staff. Nowadays, defined contribution pensions are typically offered. These types of pensions represent much less risk to employers. The main concerns for those with defined benefit pension schemes are: Companies are now facing the possibility of having to pay their retired employees for a much longer period of time than they originally thought. as people are living longer after retirement. Companies have promised to pay the annual pensions to their employees regardless of the funding levels of the overall scheme. Pensions funds of late have been experiencing increased volatility due to choppy markets.

If the company pension fund is underfunded this may put significant financial strain on company profits. Pension funds are classed as a liability on each company balance sheet. This can have a negative impact on the share price or market valuation of a company. This becomes a major problem if/when a company decides to prepare itself for a potential acquisition or buyout as the pension fund could significantly decrease the net asset value of the company. For these potential risks,

many companies, particularly those that wish to prepare for an acquisition or buy-out. Many companies have started to offer enhanced transfer values to their employees and ex-employees on their individual pension pots in order to entice them to transfer out of the scheme. This in turn will decrease the company’s liability on their balance sheet and increase their potential selling price.

How ETV’s work in practice

Since June 2016, DB pension schemes can now allow members to take a transfer from their scheme. This applies to:

  • Current employees where schemes have ceased to accrue future service benefits.
  • Deferred members (former employees not yet in receipt of their benefits).
  • Current employees may be offered the option to transfer to their employer’s defined contribution scheme, while deferred members have the option to transfer to another approved pension arrangement of their choice.

Typically, transfer values are not lucrative enough to entice employees, especially younger members, to transfer out of the existing DB scheme.

To make the transfer option attractive to members, it may be necessary to offer them an ETV

The benefits of ETVs to a company

If either a current or an ex-employee takes an ETV, their liabilities are removed from the DB scheme. This in turn reduces both the size of the scheme liabilities and the associated risk. ETVs can offer a significant saving against company accounting reserves, scheme funding, and ultimate buyout costs. This is why such lucrative transfer values are now being offered to member of these schemes. The ETV also:

  • Extinguishes all future scheme pension risk associated with the member once they transfer from the scheme.
  • Reduces accounting funding volatility.
  • Reduces the scheme’s long-term operating cost. Has a potentially positive impact on financial institutions from a regulatory capital perspective.
  • Demonstrates to key stake-holders that pension risk is being managed.
  • Reduces future regulatory risk

Benefits to members (both current and deferred)

ETVs have numerous potential benefits for members:

  • They enable deferred members aged over 50 to access their pension immediately. A member may receive a higher tax-free lump sum.
  • They enable flexibility in benefit provision and ownership of investment decisions. The member receives a higher transfer value than normal. They ring-fence members’ assets and remove any risk caused by the scheme or employer, for example that the scheme winds up in deficit or benefits am reduced An ETV may be considered to offer good value. Upon death the full values are paid to member’s estate or as per tlu wishes of the member. An ETV may suit the member’s personal circumstances in terms of health marital status, and financial status.

If you are a deferred member of a DB pension scheme it is advisable request a transfer value from your previous employer. By requesting this, you arc not committing to anything you are just assessing your options.

It is also advisable to obtain professional financial: advice before any decision is made as there are many variables to consider. such as access, security inheritance and redundancy implications. It may or may not be the best option for you to take transfer value but if it is lucrative enough, it may too hard to turn down.

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