Over the last couple of weeks, I have started to look at issues surrounding the advice given to people with preserved benefits in defined-benefit schemes. What aspects should be considered in determining whether or not to transfer these benefits to a private pension arrangement?
I finished last week's article by noting the importance of establishing the client's marital status and whether their occupational scheme will pay, or at least consider paying, benefits to a dependant.
I will start this week by looking at whether or not the client is legally married. It may seem obvious to note that, by this, I mean legally married to a partner of the opposite sex. However, the importance of this will become clear later in this series of articles.
Almost every defined-benefit scheme includes provision to pay a spouse's pension – typically, at either 50 per cent or two-thirds of the member's pension – to a surviving spouse. However, it is important to identify whether this would be the scheme member's spouse at the date of retirement or spouse at the date of death. These may, of course, be one and the same person.
Note also the crucial importance of this issue for early leavers, where a definition of spouse at date of retirement translates into spouse at date of leaving service”
Let us consider three scenarios where the definition of the scheme member's spouse would be crucial.
Married at date of leaving, subsequently divorced or widowed and remarried.
Married at date of leaving, subsequently divorced or widowed and not remarried.
Not married at date of leaving but married since that date.
Not married either at date of leaving or subsequently.
If a scheme defines a spouse as the spouse at the date of leaving, then a spouse's pension would become payable in scenario one (but note that the spouse at the date of leaving would receive the pension, not the current spouse) and scenario two (again, the divorced spouse receives the benefits) but no payment would be made in scenario three (often an unexpected outcome) or scenario four (understandably).
But if the scheme defines a spouse as the spouse at the date of death, then a payment would be made in scenario one (this time to the current spouse) and scenario three but not scenarios two and four.
What has all this got to do with pension transfers? First, it is vital that the adviser identifies the definition of spouse used by the scheme. It is also crucial to identify the client's marital situation not only at the present time – which is surely on every adviser's fact-find, in any case – but also his marital situation at the date of leaving and also if he anticipates his marital situation changing in the foreseeable future.
For example, he is not married at present but expects to marry at some stage or is married at present but is anticipating divorce (aren't we all?).
From this information, the adviser needs to identify whether a spouse's pension will definitely or probably be paid – or not – if he remains within his existing scheme.
For example, where the scheme pays a dependant's pension to a spouse at the date of leaving but the client was not married when he left the scheme, then there is no chance that a spouse's pension will ever become payable. You should be able to work out the scenarios which fit into the categories noted earlier.
Finally, the likelihood or otherwise of a spouse's pension ever becoming payable from his existing scheme – and to whom it would become payable – must be brought to the client's attention in the adviser's recommendation as this will, in most cases, have a very definite and important impact on the decision as to whether or not to transfer.
It should be remembered that, typically, between 15 and 20 per cent of a transfer value represents the value of death benefits. So, if none can be paid from a preserved pension, then the scheme will frequently (but not always) include a “bonus” 15 or 20 per cent in the transfer value for more appropriate allocation if a transfer to a private pension arrangement is effected.
If it is known at the date of a transfer analysis that, although a general provision for a spouse's pension is made in the scheme benefits, none can be payable in this particular client's circumstances, then I would strongly suggest that the existing scheme's benefit structure is input into the analysis as being devoid of provision for a spouse's pension (but, note, not devoid of a possible dependant child's pension).
This would, of course, be a “lie” to the transfer analysis software but would result in a true critical yield being calculated. This critical yield will be substantially lower than the critical yield which (wrongly) assumes the presence of a spouse's pension as the transfer value is only trying to match a single-life pension, thereby, in effect, starting with a gain of 15 or 20 per cent.
If nervous about “lying” to the analysis software (although bringing the reason for this to the client's attention when presenting the report), the adviser should at the very least present the standard report, giving an unfairly high critical yield, and strongly bring to the client's attention the fact that, although the report assumes a widow's pension would be payable, this is not the case or, in different circumstances, is unlikely to be the case.
This issue, although right at the start of our tour round important pension transfer issues, in itself shows that a much higher proportion of preserved pension enquiries should be transferred than might otherwise be apparent if the importance of the definition of spouse is not properly investigated by the adviser.
As yet, I have only looked at the position regarding legally-married spouses. Next week, I will look at common-law partners of the opposite sex and same-sex relationships.
In the meantime, consider this final important issue which, in a significant number of schemes, might also affect entitlement to a spouse's pension benefits and thereby have the same affect on the decision as to whether or not to effect a transfer.
A number of pension schemes stipulate that a spouse's pension will only be payable to a spouse (whether at the date of leaving or date of retirement) with whom the scheme member was living at the date of his or her death. If the spouses were separated, albeit still married, at the date of death and the scheme becomes aware of that fact, then payment of a spouse's pension can (and usually will) be withheld.
I was made aware some years ago of a very big scheme withholding payment for this reason to a widow who had not been living with her husband immediately prior to his death, due to him living in an intensive-care nursing home during his final years of very poor health.
I would hope this represents an isolated incident of trustees not exercising discretion but the importance of this living-together clause should not be underestimated for couples who are separated.
Keith Popplewell is managing director of Professional Briefing