Many individuals have pension benefits in a personal retirement bond (PRB) without necessarily understanding what they have and what steps they should follow to make the most of these benefits before retirement hits them – often too late to do anything!
Sources – DB + DC
A PRB is an individual pension contract designed to invest pension benefits which have been accrued in an Occupational Pension Scheme of an employment which the individual has left. For members of a defined contribution (DC) scheme who decide to transfer their benefits to a PRB the options available at retirement are the same under both the scheme and the PRB. Up until recently, the vast majority of PRBs originated from such schemes.
The situation is somewhat different for defined benefit (DB) schemes, however. When members left these schemes their benefit was guaranteed and so they typically left the benefit they had accrued “deferred” in the scheme until retirement.
However, many DB schemes have become unsustainable in recent years and trustees have often made the decision to wind-up schemes and transfer the assets of current members to defined contribution arrangements. For those holding a deferred benefit in a DB scheme this typically meant the benefit transferring to a PRB.
A PRB for a member transferring from a DB scheme is a major change as the guaranteed fixed benefit at retirement is gone and the member must take on the responsibility for the investment risk. Choosing an appropriate strategy for investment can significantly affect the outcome at retirement.
Differences – DB + DC
There is one other major difference between a PRB coming from a DB scheme than one from a DC scheme which is often lost on individuals in this situation.
* At retirement, after providing for a lump sum based on the rules of the transferring scheme, the remaining balance of a PRB which originated from a DB scheme must be used to purchase an annuity.
* However, members of DC schemes are in a very different position and can opt to invest in an approved retirement fund (ARF) or purchase an annuity. They also have the option of taking a tax free lump sum worth up to 25% of their fund subject to Revenue limits.
Currently, the majority of defined contribution scheme members are choosing the ARF option. This is mainly due to the fact that the cost of annuities have risen substantially as a result of longer life expectancy and historically low bond yields.
Unfortunately, when an annuity is purchased for the rest of an individual’s life it is based on the rate available on the day of purchase – regardless of the fact that rates may increase over time if interest rates rise. An ARF, on the other hand, delivers a return based on market performance as time goes on rather than at a single date.
To most this, perhaps unintended consequence, would appear to be very unfair. Most DB wind-ups result in members receiving a value which is less than the full cost of providing the benefits intended by the scheme, and now members are being penalised again for not having the same options as a DC member would have despite the fact that both are carrying the investment risk.
There are steps which can sometimes be taken to ensure that this does not happen. Generally speaking, a member of a DC scheme in their current employment can transfer a PRB into that scheme and avail of their ARF entitlement on retirement. If they are not a member of a DC scheme they may be in a position to set one up provided the scheme meets the requirements of the Revenue to allow it to be an approved scheme.
These and other requirements make it absolutely essential to take professional advice before making any decisions.
John has over 25 years’ experience in the Irish pension industry having previously worked with Coyle Hamilton Willis and Irish Life. John is an Associate of both the Irish Institute of Pensions Managers and the Pensions Management Institute. John was previously a Director of Traders Financial Services (Cork) Limited, which was acquired by Invesco in October 2009.
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