How a Rolls Royce benefit has become a "clapped out banger”

The quickening end to Defined Benefit Pension Arrangements

New statutory requirements relating to funding defined benefit schemes have recently become law with the coming into force on 1st May of the Social Welfare and Pensions Act 2012. The new rules set down will inevitably lead to an increase in the wind-up of defined benefit pension structures. This is due, among other things, to the new requirement for a “risk reserve” (additional funding) to be set aside to act as a buffer against further economic turmoil. These new measures are of course going to add further pressure on company balance sheets and indeed we have already seen in the past week AIB and Independent News and Media announce their intention to shut down their company defined benefit schemes.

Defined Benefit schemes have long been considered the Rolls Royce of pension structures offering a guaranteed pension for life based on an employee’s final salary. However, in recent years these pension schemes have been under severe pressure due to volatile asset values and increasing liabilities which have been caused by bad investment performance, low German bond yields and increasing life expectancy. These issues coupled with a difficult business environment, increasing taxation and regulation, and a poor economic outlook have caused employers to consider restructuring their company pension arrangements. The new funding rules introduced by the Social Welfare and Pensions Act 2012 will now force employers to make decisions (as early as this December) they had been hoping to avoid with such decisions having an immediate impact on company employees.

Take an employee who has been a member of her company’s defined benefit pension for the past fourteen years. She has been contributing 6% of her gross salary every year of her employment with a matching contribution by the employer, but is still sixteen years from her retirement age. Unbeknownst to her, much of the contributions she has being paying in to the scheme have been used to pay the pensions of the retiring employees of her company. Over the past 14 years, she and her employer have each contributed approximately €42,000 to the scheme and she believed that she had amassed a fund of €84,000+ allowing for investment growth and charges. Her company have now decided to wind up the defined benefit scheme and transfer her benefits to a defined contribution arrangement. It is at this point she realises that not only does she have less in her pension than she originally thought she actually has less than her own contributions. One of the main reasons for this is the legislation governing defined benefits pensions require the scheme trustees to give 100% priority to retired members so some of the money she thought she was saving for herself actually went to people she’s probably never met (unless she attends the company’s annual retirement do). In essence her Rolls Royce benefit has become a clapped out banger.

So what are a member employees options now and what can they expect from their employer? All employers are required by law to ensure their company employees have some access to a pension arrangement so it cannot be a case of walking away from responsibilities. Companies will have to consider restructuring their pension offering which will involve establishing some type of defined contribution structure. Employers and employees are increasingly looking at other pension arrangement options such as one member pension trusts or Personal Retirement Saving Accounts (PRSAs) to avoid the risks of underfunding and to bring some sense of equity, fairness and transparency to their pension provision which they do not perceive as being possible under the defined benefit structure. These structures also allow an individual and employer to control the cost of pension provision.

The realisation that defined benefit is not a guarantee of benefits at retirement will be an unwelcome message for most employees, but it is better they know now rather than at the point of retirement when their options are restricted. The financial implications of such changes to their pension arrangements will be specific to each employee. Some of the differences include different methods of calculating tax free cash lump sums, making individual investment decisions if the employee wants to and decisions on what can be done with their retirement fund at retirement, such as reinvesting in an Approved Retirement Fund (ARF) or deciding when or what type of pension to buy.

The access to the ARF regime after retirement has been significantly widened recently for members of defined contribution pension arrangements. The ARF option allows someone who has retired to pass a capital sum to his or her family after their death. However, this option is not available to retired members of defined benefit schemes.  After retirement, the majority of members of defined benefit schemes are limited to taking an annuity which can prove to be expensive and inefficient for estate planning purposes. 

The switch of decision making and responsibility for funding to provide sufficient benefits for employers to employees has been occurring gradually, but the new funding rules for defined benefit pensions under the Social Welfare and Pensions Act will accelerate the change. This presents an opportunity to create flexible pension arrangements that will allow employers and employees fund for their retirement while giving control of how these are funded and drawn down to the employee.

Paul Gilmer
Solicitor
ITC Consulting

Aidan McLoughlin discusses upcoming regulation and future changes in the Irish Pension Market at EPI Summit

Aidan McLoughlin, Managing Director of Independent Trustee Company recently attended the European Pension and Investment Summit in the Netherlands. As a delegate at the event, Aidan was asked his opinion on upcoming regulation, the European approach to structuring pensions and future changes in the Irish pension market. You can view the full interview by clicking on the image below.

Independent Trustee Company

NEST: Protecting their young?

The UK government is making changes to encourage people to save for retirement. The Pensions Act 2008 introduced new duties on employers to provide access to a workplace pension scheme. All employees will be automatically enrolled into an occupational pension (unless they opt out) and where employers do not already have a scheme, people’s money will be invested in NEST. NEST (National Employment Savings Trust) will be a universal, defined contribution scheme, accumulating a fund during a workers life to purchase an annuity on retirement.  It is due to commence in October 2012.

Much scrutiny has been given to the investment choices that NEST will make available to their members. When it comes to the funds that NEST invests their members in in the early years this differs substantially to what is typically used in standard Defined Contribution Lifestyle funds in Ireland. 

NEST carried out extensive research and consultation and as a result they found that when it comes to younger members- those under 30- that they’re especially sensitive to volatility and loss and are most likely to act adversely in the face of such volatility.  NEST will invest younger members- in their 20’s - initially in funds that will target investment returns that look to match inflation after all charges have been taken out.  The next phase where members will spend the majority of their time circa 30 years, will target returns of inflation plus 3% after charges, the final stage is designed to manage the risk of shocks closer to retirement.

Niamh Quirke

Independent Trustee Limited

The Pensions Board publishes funding rules for defined benefit pension schemes

Yesterday, the Pensions Board published revised rules for defined benefit schemes and announced the deadlines by which trustees must submit funding proposals to the Board to deal with scheme deficits.

The full Press Release on the revised rules can be found on the Pensions Board website. 

Sovereign Annuities – How will they work?

The scale of the funding crisis in Defined Benefit Schemes has been a topic of much debate for the last number of years. One of the solutions proposed by government was to introduce a Sovereign Annuity option. As the yield on Irish Government bonds is higher than the yield on the bonds normally used to back annuity the effect should be to reduce the scheme’s liabilities. Thus a sovereign annuity is designed to ease funding pressures on a Defined Benefit scheme, provide a source of funds to the State and also to adjust the priority rules in a more acceptable manner.

The first sovereign annuity product is due to be launched in the coming weeks. Initially, this sovereign annuity product will be based on Irish and French bonds. It is expected that this will mainly be of interest to schemes which are in wind up and in some cases where the employer company is also in liquidation. It is estimated that the total value of the sovereign annuity market will be approximately €2-3 billion.

However this sovereign annuity product will only be available to pensioners and not to active and deferred members. This causes a dilemma for the trustees: are you disadvantaging pensioners (by linking their pensions to sovereign annuities) to improve the position of other member classes (by increasing the amount of the fund available to pay for their benefits)?

So it remains to be seen how sovereign annuities will work in practical terms. It will be interesting to see how trustees and pension scheme members will react to this new and long awaited product.

Aisling Daly

Independent Trustee Limited