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Quick on the draw?

Technically speaking with Keith Popplewell

In this series of articles, I have been identifying and explaining the implications for pension advisers and their clients of recent and imminent developments in various areas of the pension world.

A number of these issues have a significant impact on the advantages or otherwise of transferring preserved benefits in a former employer’s defined-benefits pension schemes, as I will now itemise and discuss in this article.

At the beginning of this series, I wrote about the issue of age discrimination by pension schemes, noting the trend over recent years not only to increase normal retirement age but also to impose significant penalties on those members who choose to withdraw benefits before that age.

I suggest – mostly because of the funding burden on schemes of increased life expectancy – that this trend is likely to continue. Members are going to have to wait longer to draw their pension benefits or suffer punitive penalties if they want to draw an income before that stated age.

This trend should be noted by all financial advisers and brought to the attention of clients when planning future cashflow requirements.

For those advising on the possible merits of pension transfers, this issue has particular significance. In my experience, many clients with preserved pensions want to start to draw their benefits before the normal retirement age of their previous employer’s scheme. Even when it is brought to their attention that the income from their pension fund will be substantially higher for each year they defer taking their pension, the desire to achieve an early or, in some cases, immediate income frequently outweighs common sense.

Some preserved pension clients ask why they should bother to transfer their benefits when they can simply start to draw them immediately from their previous employer’s scheme. Sometimes this is possible but, as an increasing number of pension schemes have fallen into a significant underfunded position (especially as defined under amended reporting regulations), more schemes have barred their members from taking benefits before the scheme normal retirement age. Thus, any member wanting to draw their benefits before that age have no choice but to first of all effect a pension transfer to a personal pension or buyout bond.

It is noticeable that even those schemes which permit early withdrawal are imposing higher penalties than has previously been the case – a 4 per cent penalty for each year of early withdrawal is now by no means uncommon, meaning that someone seeking to take an income from their preserved pension 10 years or so before the scheme’s normal retirement age will have their accrued pension reduced by about a half. Thus, the changes in funding requirements have a direct impact on early retirement benefits.

I have also covered the issue of sex and sexuality discrimination, noting in particular the ways in which different final-salary schemes provide death benefits to legally married spouses, heterosexual partners in common-law relationship and same-sex partners.

It remains the case (as evidenced by the annual surveys of employer-sponsored pension schemes by the National Association of Pension Funds) that many pension schemes, especially those in the public sector, will not consider paying a dependant’s pension to a same-sex partner. Even where this is not a definitive restriction within the pension scheme rules, payment to a samesex partner will almost invariably only be made at the discretion of the trustees.

This should not be viewed as a formality. Imagine if you were a trustee of a pension scheme and, following the death of one of your members, you receive a request for a substantial dependant’s pension from a person claiming to be the deceased’s same-sex partner. There is still no legal procedure for this couple to evidence their commitment to each other, so what will the trustee require to determine if the claimant is deserving of the pension? Evidence of the period of the relationship will almost certainly be required – not always as easy to prove as it may sound.

Evidence of joint financial commitments would also be useful. A mortgage in joint names is perfect in this respect but, in my experience (and I am citing this evidence with no degree of homophobia), same-sex couples usually do not have joint mortgages.

Dependent children of the couple (a major factor in similar decisions for claims from common-law partners) are clearly not an issue. So what are the chances of a dependant’s pension claim from a same-sex partner succeeding? Remote, in reality.

Had they been legally married for even just a day or two, having perhaps only known each other for a few weeks, the pension would be paid to the spouse without referral to the trustees or the scheme administrators but, because the legal marriage of same-sex partners is not yet possible, this problem remains for people in these relationships.

The message for those advising on preserved pensions? First, it is vital to ascertain whether the client or prospective client is homosexual. In my training sessions and seminars, this suggestion has invariably raised smirks and titters, if not outright guffaws, as many advisers suggest they simply cannot include such a searching question in their fact-finding. When the laughter subsides, I stress the importance of my suggestion and seek to make the advisers realise that homosexuals would not be offended by this line of questioning, especially when the relevance is explained.

Put simply, depending on the age of the scheme member and a small number of other factors, typically around 30 per cent of the value of preserved pension benefits lies in the dependant’s pension. For example, out of a transfer value of, say, 50,000, the member’s personal entitlement will be worth 35,000, with the dependant’s pension representing the remainder.

If a client in a same-sex relationship is a member of a scheme which will flatly refuse to pay a dependant’s pension to his or her partner, they are faced with a simple choice – leave their benefits in their previous employer’s pension scheme or cut and run by transferring benefits to a personal pension under which any person can be nominated to receive the death benefits. Moreover, this nomination can be changed at any time, perhaps as relationships change.

Before further investigating the impact of recent and upcoming developments on pension transfers in my next article, I will close by looking at the situation for common-law partners of the opposite sex. Much the same issues exist, really, as for same-sex partners – surviving partners of a deceased scheme member will be automatically denied benefits from a significant minority of final-salary schemes as the couple were not legally married. Where the scheme rules permit consideration of payment, it will invariably be at the trustees’ discretion and, as I have noted with regard to same-sex partners, this should not be taken for granted.

A common-law relationship where only one partner is on the rental or mortgage agreement, where there are no joint children and especially where the period of cohabitation was only a few months or years will almost certainly indicate a refusal of a dependant’s pension to the surviving partner. As more and more relationships never result in legal marriage, this is a vital issue in pension planning,I would suggest.

More about pension transfers in my next article.

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