UP TO 250,000 workers are at risk of making the wrong pension choices when they change jobs or when their employers shut down company schemes that have become insolvent.
Pensions are portable between jobs and employers’ schemes but the pitfalls are considerable if you make the wrong decision.
According to Standard Life, up to a quarter of a million people will end up in buy-out bonds in the next five years as their pension arrangements change, but most have no idea of what these bonds involve.
Sales of buy-out bonds have soared as insolvent defined benefit (DB) pension schemes are wound up and members take control of what is left of their retirement benefits. The number of DB schemes, which are struggling to meet their promise of a pension based on salary and service, has dropped from more than 2,500 to fewer than 1,000 in the past 20 years (see chart). Those changing jobs as the economy recovers are also expected to drive the sale of buy-out-bonds as they take their pensions with them rather than leave them in their previous employers’ schemes.
Up to 90% of people have no idea how buy-out bonds work. Jim Connolly, head of pensions at Standard Life, said: “The number of people who will take out a buy-out bond is massive but there’s a huge lack of knowledge about them.”
Advertisement
We tell you what you need to know.
WHAT ARE BUY-OUT BONDS?
Buy-out bonds are a way of taking pension benefits with you if you leave employment before retirement, change jobs or if your pension scheme is wound up. “They are like a home for an orphan pension benefit,” said Connolly.
Buy-out bonds allow you to consolidate your pension benefits from previous jobs into a single investment, which you own and control. Funds cannot be accessed before retirement, however.
Advertisement
More workers will see their pensions end up in buy-out bonds as employers renege on promises to pay a guaranteed pension for life.
Jonathan Roche-Kelly, head of financial services at First Ireland, an adviser said: “The majority of DB schemes are insolvent and it is anticipated that half of them will wind up over the next five years.”
WHO SHOULD KNOW ABOUT THEM?
“If you have ever had a job with pension benefits, you have money that could potentially go into a buy-out bond, or could already be in one,” said Connolly.
Advertisement
Members who are too young to retire have three options for taking their entitlements when DB schemes are wound up: a buy-out bond, a personal retirement savings account (PRSA) if they have fewer than 15 years’ service, or moving the entitlements to a new employer’s scheme.
Those changing jobs have a fourth option: leaving their pension benefits with their previous employers.
Transferring your pension fund to a new employer’s scheme is seen as the worst option. “I cannot see any benefit because you lose access to it until you leave that employer,” said Connolly. “You could find yourself in a situation where you have locked your pension away at a time when you need to access it.”
Buy-out bonds and PRSAs allow greater control over how your pension is invested and when it can be accessed. “If you go into an employer scheme, you have to go into the investments that the trustees of that scheme choose. A buy-out bond or PRSA gives you free rein as to what your pension is invested in,” said Connolly.
Advertisement
BUY-OUT BOND OR PRSA?
Liam Ferguson, of Ferguson & Associates, an adviser, said: “The choice is not straightforward and there are pros and cons for each.”
Buy-out bonds have more flexible charges, while PRSA charges are regulated by law. “Most PRSAs have an annual charge of at least 1% while buy-out bonds can be arranged with lower annual charges,” Ferguson said.
Transfers to PRSAs can involve more paperwork. If the value of your fund is more than €10,000, you must obtain a certificate of benefits comparison from an actuary before transferring to a PRSA, which can be costly. This is not required for buy-out bond transfers.
Advertisement
Workers with DB pensions are banned from transferring to PRSAs if they have been members of the DB scheme for more than 15 years.
Buy-out bonds can be accessed from age 50 compared with 60 for PRSAs. You may also be able to withdraw a bigger tax-free lump sum from a buy-out bond because of differences in how the payments are calculated. Eoghan Creevey of Harvest Financial Services, an adviser, said: “Buy-out bonds have a wider investment scope that PRSAs.” This is because they are not subject to the same regulation as PRSAs, allowing them to invest in a wider range of assets such as shares or direct property investments.
The reasons for transferring to a PRSA include the freedom to continue making pension contributions before you retire. Buy-out bonds cannot be topped up in this way, although you could make contributions to other pension funds you may have.
A key advantage of PRSAs is that your fund can be transferred to an approved retirement fund (ARF) when you stop working, allowing you to keep your pension investments intact and tax-free during retirement.
ARFs are not an option if you have a buy-out bond that came from a transfer out of a DB scheme, although the restriction does not apply to transfers from defined contribution schemes.
ARFs are attractive because the alternative, a retirement annuity, offers poor value. It pays a guaranteed income for life but low interest rates and growing life expectancy mean the amount is meagre in most cases.
Also when you die, an annuity dies with you whereas you can pass on what’s left in your ARF to your family when you pass away.
“If you’re coming from a DB scheme and you have less than 15 years’ service, the ideal option for you would be a PRSA,” said Connolly
CHOOSING A PROVIDER
According to Kelly there is no single provider where you should invest your buy-out bond.
“Every case is different and should be measured on its own merits. A good adviser will bring you through the strengths and weaknesses of each. What is important is to ensure that you get value for money,” he said.
In Kelly’s view the provider you select should offer a diverse range of investment options that can match your changing circumstances over time.
“There are many options available, from low- to high-risk funds, investing in particular types of assets. These include multi-asset funds that invest in a spread of assets and self-directed funds where you choose what assets you invest in like shares or direct property,” he said.
When investing in a buy-out bond, you need to compare not only the charges but also brokers’ fees as well as be aware of early encashment penalties.
“Charges depend not only on which company you go with; they also depend on which broker you choose,” said Ferguson.
“Two identical buy-out bonds arranged by two different brokers with the same company could have different charging structures so you need to shop around,” he said.