Defined-benefit pensions: Perhaps most valuable asset you own

Defined-benefit (DB) pension schemes are the gold-plated generous older brother of their defined-contribution equivalent. They offer a guaranteed income upon retirement, linked to your final salary and in line with inflation, regardless of the performance of the fund’s investments.

Such schemes are both luxurious and costly and, unsurprisingly, they began to fall out of favour as their relative expense rose in line with our life expectancy. The “job for life” is becoming a distant memory and such schemes became less relevant for an increasingly peripatetic workforce.

But while DB pensions schemes have been in decline for a long time, that doesn't mean they have disappeared. According to the latest figures from the Pensions Authority, the number of defined-benefit schemes in Ireland has fallen from over 2,500 in the early 1990s to fewer than 600 nowadays.

According to a 2018 survey carried out by the Irish Association of Pension Funds (IAPF), which involved 65 companies, 20 per cent of those surveyed still had a DB plan in place that was open to new entrants and future accrual of benefits.

About three-quarters of the companies surveyed had legacy DB arrangements in place which are closed to new members, and half of these were closed to future accrual. Meanwhile, 39 per cent of closed DB schemes had removed future service accrual for existing active members.

But while a DB pension is “guaranteed”, it isn’t bulletproof; this all depends on the scheme’s ability to fund its pension obligations for all members – and the employer’s willingness to make up any shortfall – meaning they still carry inherent risks.

“It is important to know that DB scheme benefits are not guaranteed. If the scheme’s assets are not sufficient to pay the benefits, and the employer is not in a position to meet the shortfall, promised benefits may have to be reduced,” says the Pensions Authority on its website.

Explore your options

Turbulent times in the world of finance mean that both active and deferred (past member of a defined-benefit pension scheme who has not reached retirement) members of these schemes who are concerned about the future are now exploring their options.

There are still more than 300,000 members of Irish defined-benefit schemes with 200,000 of those yet to reach retirement age in their scheme, says John O’Hara, actuary and private client adviser with Davy. He explains that defined-benefit pension schemes have become far more costly for companies to provide than could have been foreseen when they were first put in place.

“Life expectancies for individuals at retirement have increased significantly in the last 50 years resulting in schemes paying out pensions for longer while returns on government bonds and cash, assets which defined-benefit pension schemes are required to hold, are at historically low levels in today’s zero-interest-rate environment,” he points out.

For many pension scheme members, their defined-benefit pension will be the most valuable asset they own, but many take the benefits for granted, O’Hara warns.

“My advice to concerned active and deferred members is to become better informed on both their entitlements in the scheme and the sustainability of the scheme itself. Members should review their annual pension statement to understand the benefits payable to them at retirement and where possible attend any briefings or updates on the pension scheme.” Both the Pensions Authority and scheme trustees are constantly seeking to improve the standard of communication to pension scheme members so there should be plenty of material available for members to review, he adds.

Qualified advisers

Proper planning is thus critical if you are approaching retirement age. O’Hara says that in the years leading up to retirement, members should engage with a qualified adviser who can help them put together a financial plan for retirement incorporating their pension benefits as well as any other sources of income a member may have in retirement. This includes examining all their options when it comes to their defined-benefit scheme. For example, deferred members have the option of leaving the deferred benefit in the DB scheme until retirement, or transferring the value into a policy in their own name.

“Some members may wish to explore the option of converting their defined-benefit pension into a capital value in order to take control over the management of their pension benefits, however, such an important and complex decision should not be made without first seeking financial advice,” he cautions.

Those concerned about the viability of the scheme they belong to are right to be alert: according to O’Hara, the main risk to members of DB pension schemes is that the employer winds up the scheme resulting in a reduction to members’ benefits. In some cases, this can be markedly less than what they would have originally expected, he says.

“Pensioners already in receipt of their benefits are well-protected in this scenario as they have first priority on the scheme’s assets but active and deferred members could find themselves in receipt of a transfer value, which is the capitalised value of a defined-benefit pension, and which may not afford them an equivalent level of retirement benefits to those promised under the scheme,” he says.

“In my experience, however, most companies seek to do their best by scheme members in these scenarios by shoring up any funding deficit in schemes in order to provide higher payments to members or by replacing defined-benefit schemes with generous defined-contribution pension benefits.”