Navigating Defined Benefit Schemes

Introduction

Navigating the world of pensions can be complex, especially when it comes to defined benefit schemes. Let’s delve into a recent consultation we had, which sheds light on the intricacies of making informed retirement decisions.

The Client’s Scenario

Recently, a client, who’s turning 60 this year, approached us. She’s part of a defined benefit scheme with a prominent US tech firm. Her primary concern was whether to accept the benefits proposed by the scheme. As financial advisors, our general stance is to recommend staying within the primary scheme unless there’s a specific advantage tailored to the client’s situation. For instance, someone with severe health concerns might prioritize securing their pension’s value for their family.

The offer on the table for our client was a €65,000 per annum pension, guaranteed for five years, a 50% spouse’s pension, and a lump sum of €174,000. When considering the lifetime allowance, the pension’s estimated value, inclusive of AVCs, stands at €2.2 million. This means there’s a tax implication since it surpasses the €2 million lifetime allowance. Consequently, our client halted her AVC contributions, leaving her with an AVC fund of €720,000. The cash equivalent of her defined benefit scheme is approximately €1.2 million, bringing the total estimated cash value to about €1.92 million when including the AVCs.

Our Analysis and Recommendations

After thorough evaluation, here’s what we suggested:

1. Opt for Cash Equivalent Transfer Value: We advised her to consider the Cash Equivalent transfer value (around €1.2 million) and combine it with her existing AVC fund of €720,000. This can then be moved into a Personal Retirement Savings Account (PRSA).
2. Lump Sum Benefits: Under PRSA rules, she can claim a maximum lump sum of 25% of the fund value (up to €500,000). This contrasts with the defined benefit scheme’s maximum of €174,000. From this €500,000, the initial €200,000 is tax-exempt, while the subsequent €300,000 incurs a 20% tax. This means she could potentially receive a net payment of €440,000.
3. Vested PRSA Benefits: The remaining pension fund, approximately €1.5 million, would be placed in a vested PRSA. This is akin to an Approved Retirement Fund (ARF). Given our client’s risk tolerance and her lack of dependents, we suggested purchasing an annuity with the entire pension fund.
4. Annuity Insights: Currently, a joint life annuity offers a rate of 4.52%. This provides a guaranteed lifetime income of €67,800 per annum, an increase of about €2,800 annually compared to the main scheme’s offer.
5. Delaying Annuity Purchase: If she chooses to postpone the annuity purchase, the vested PRSA would function similarly to an ARF. She’d need to draw an annual income of 4% until age 71, after which it would increase to 5%. The initial income would be at least €60,000 per annum.
6. Additional AVC Contributions: By following our recommended strategy, she could potentially make an AVC contribution of €84,333. This would attract a 40% income tax relief, bringing her total pension fund value close to €2 million upon retirement.

Conclusion

Every individual’s financial situation is unique, and there’s no one-size-fits-all solution. This case study underscores the importance of personalised financial planning. It’s crucial to move beyond generic advice and consider the specific circumstances at hand. Making informed retirement decisions can significantly impact one’s future, and it’s always best to seek expert guidance.