Selling a Defined Benefit Scheme

[Martynt74]

I was chatting to a mate this morning and he had a DB scheme for a few years with his current employer.

At the moment it stands where he gets a £10k lump sum and then £7k per year.

His employer are trying to clear their DB liabilities and are offering to buy employees out of the scheme. The money would then be transferred into a DC pension pot for him to do as he wishes.

He applied for a quote and has been offered £410k. I just don't understand the logic behind the companies offer. Assuming he lived to 100, that's about 40yrs of pension plus the 10k lump sum which only comes to £280k.

Surely the smart option would be to take that £410k lump sum and stick it in the DB scheme. That then covers their liability and adds over 100k for other liabilities.

I'm going to tag @Pudney in here, but is there anything obvious i'm missing?

(I'm ignoring inflation as both the 7k, 10k and 410k are all in todays money and will all inflate in line)

 

[touch]

Is the £10k and £7k/year just what he would get if he retired now? Could that change based on salary or time served or something?

 

[Martynt74]

No, it's locked in at those figures as the DB scheme shut down back in 2010. He's now on a pretty generous DC scheme.

 

[Hagar]

Yes, payments in regard to inflation, in my DB scheme it was at least 2.5%, at least RPI, no more than 5% per annum. This was in effect even though the scheme was in abeyance (deferred) as I had left the company. The fund also will continue to grow with investments until it is actually in payment.

Surely the smart option would be to take that £410k lump sum and stick it in the DB scheme. That then covers their liability and adds over 100k for other liabilities.

Cannot do that as the £410k would be liable to be taxed at punitive rates.

 

[leezer3]

With DC all the risk is on your friend.

If we had a massive crash & all equities halved in value, then all of a sudden he's only got ~30 years of money in the pot.

The DB will almost certainly have inflation related increases when retired too, which the DC will not; All increases would have to come either out of the pot (reducing income) or growth.

It's almost never a good deal in the long run to take up this sort of offer.

 

[Rotty]

Cannot do that as the £410k would be liable to be taxed at punitive rates.

if its possible to do as a transfer then it's not liable to tax

 

[Deleted member 651465]

Guys in my last place of work were offered 35-30x the value of their pot. Some people got £600-700k out of them (BP). Madness.

 

[KingOfTheDaves]

If the scheme is carrying out an enhanced transfer exercise (and a CETV of 58 times the DB pension sounds like it has been enhanced) then the DB scheme will almost certainly be closed to both new entrants and transfers in for existing members so you wouldn't be able to do that.

As this is still his current employer he is unlikely to have another DB scheme to transfer to, so that leaves DC.

All transfers from DB to DC over £30k need to be signed off by an IFA anyway, will only authorise if it is in the members interest.

As leezer states above, transferring out of a db scheme is often a bad idea, but a CETV of 58 x the db pension is at least worth asking an IFA for their opinion.

 

[Martynt74]

that leaves DC.

Sorry, i might've worded it badly. I meant i don't understand why the company wouldn't transfer the money they would be paying out into their DB pot. It'd more than cover the cost of paying out the employee with extra leftover.

Whilst i accept a crash might happen, i don't think there's a point in recent history where an asset such as this hasn't at least held it's value over 30 years. Even during the 2008 crash i imagine the FTSE (for example) was still worth a hell of a lot more than it was in 1980

 

[wesimmo]

With DC all the risk is on your friend.

If we had a massive crash & all equities halved in value, then all of a sudden he's only got ~30 years of money in the pot.

The DB will almost certainly have inflation related increases when retired too, which the DC will not; All increases would have to come either out of the pot (reducing income) or growth.

It's almost never a good deal in the long run to take up this sort of offer.

All things being equal, I'd agree, DB is in most cases better than DC.

I've got a friend who is pretty much locked into his employer as he's been there for 20+ years on DB and it continues for as long as he's employed.

He reckons it'd need a £20k a year pay rise to make it worth him moving from a pension perspective

 

[Freddie1980]

I was chatting to a mate this morning and he had a DB scheme for a few years with his current employer.

At the moment it stands where he gets a £10k lump sum and then £7k per year.

His employer are trying to clear their DB liabilities and are offering to buy employees out of the scheme. The money would then be transferred into a DC pension pot for him to do as he wishes.

He applied for a quote and has been offered £410k. I just don't understand the logic behind the companies offer. Assuming he lived to 100, that's about 40yrs of pension plus the 10k lump sum which only comes to £280k.

Surely the smart option would be to take that £410k lump sum and stick it in the DB scheme. That then covers their liability and adds over 100k for other liabilities.

I'm going to tag @Pudney in here, but is there anything obvious i'm missing?

(I'm ignoring inflation as both the 7k, 10k and 410k are all in todays money and will all inflate in line)

He'd be better off taking the companies offer IMO. Currently he will get £7k (index linked) and if he drops dead in a years time after taking out his pension typically half the value goes to your partner. If he takes the £410 and puts it into a DC he can then sell it for a annuity (this will vary depending on his age) and again there will be a death benefit where about half the pension is inherited to his partner. Alternatively he could keep the $410k in the DC pension scheme and keep it invested rather then selling it and do income draw down at 4% which would be £16,400 PA. Invested well his pension should grow faster then 4% which will mean each year he will be better off. Even better by keeping the money invested it forms part of his estate when he dies so the full amount can be inherited by his wife or next of kin (you could even put it in trust to avoid inheritance tax if he wanted to do and still draw down income via a trustee).

 

[Pudney]

Sorry, i might've worded it badly. I meant i don't understand why the company wouldn't transfer the money they would be paying out into their DB pot. It'd more than cover the cost of paying out the employee with extra leftover.

Whilst i accept a crash might happen, i don't think there's a point in recent history where an asset such as this hasn't at least held it's value over 30 years. Even during the 2008 crash i imagine the FTSE (for example) was still worth a hell of a lot more than it was in 1980

The accounting requirements can actually be quite surprising, particularly on the volatility front. Predicting 30+ years into the future is basically impossible, and the general theory of prudence in accounting makes it worse.

To give you an example, an old client of mine around 2009 had a £1 million surplus in their DB scheme in 2009 (about £20m turnover and 100 staff) and in 2010 it had moved to a £300k deficit. The only change was the return on investments. If you multiply that up to 1,000s of staff the financial cost can be horrific and essentially un-manageable as it is entirely reliant on outside factors. That kind of volatility alone is enough to persuade a business to heavily incentivise staff to move over into a DC scheme particularly in years where business performance/assets are strong.