In my previous piece in this series of articles examining recent and imminent changes to pension planning, I started to concentrate on issues affecting the decision as to whether or not an early leaver from a final-salary scheme should consider transferring their benefits to a private pension arrangement.I discussed the vital importance of considering a client’s marital status in relation to the definitions of dependent used by the former employer’s scheme, concentrating on the situation regarding homosexual or common-law partners of scheme members who, depending on the provisions of the scheme, may be denied a surviving spouse’s pension. I now want to develop this discussion further, before looking at other important factors in the transfer decision, by noting issues relating to legally married spouses. This is another aspect of pension planning which has seen continuous change in recent years although not as a result of legislation. When a scheme actuary determines the funding requirement and solvency position of a final-salary scheme, they must take into account all the benefits promised by the scheme. The primary benefit is, of course, the member’s own pension but a significant proportion of the total funding requirement – typically between 20 and 30 per cent of the total – is accounted for by the promise made by almost all final-salary schemes to pay a pension to a surviving spouse or dependent. A smaller amount, around 5 per cent, may also be identified where the scheme promises to pay a lump-sum benefit on the death in service of a member. The purpose of my noting these proportions is not, in the context of this article, to further discuss developments in scheme funding requirements (which were the subject of a recent article in this series) but to consider the impact on deferred scheme members or early leavers. The value of the dependant’s pension promise must usually be included in calculating a transfer value for deferred members. Thus, out of a transfer value of, say, £50,000, the value of the dependant’s pension promise will typically represent at least £10,000. But what about deferred members who are not married? If these people remain in their former employer’s scheme, they will retain the valuable promise to pay a member’s pension at retirement age but the promise to pay a pension to the surviving spouse or dependant – worth notionally around £10,000 – is in reality worthless in their particular circumstances. To relate this issue back to my last article, the same applies where the client is in a same-sex or common-law relationship where the scheme rejects a claim from a surviving partner. Where it is confirmed that the scheme provides a surviving spouse’s pension, almost every pension transfer analyst will input this fact into the transfer analysis program to determine the required investment growth rate in a private pension to match the benefits the deferred member would be giving up from the existing scheme. Let us say, in an example case, that this required growth rate, usually known as the critical yield, is 9 per cent a year. This might be considered by many analysts as not being realistically achievable in the longer term although it is not by any means the highest critical yield we have seen in recent years. My point is this – if the analyst has identified that the member’s benefits do not include a dependant’s pension, then a transfer of his benefits to a private pension arrangement would result in a “windfall” profit of £10,000, as all the £50,000 would be working towards his own retirement benefits whereas only £40,000 was working in this way while he left his benefits in his previous employer’s scheme. In these circumstances, I would suggest that the pension transfer analyst should input into his program the assumption that the scheme does not grant a surviving spouse’s pension, that is, the only benefit payable by the former employer’s scheme is the promised member’s pension. This then requires the pension transfer program to calculate a critical yield compar- ing a private pension with a single-life pension in the existing scheme, resulting in a significantly reduced required investment growth rate in the private pension of, say, 7 per cent a year as opposed to 9 per cent if the private pension was trying to match the inclusion of an illusory spouse’s pension. I am not suggesting this reduced critical yield means a transfer should be recommended but it is obvious that the decision over whether or not to transfer would clearly have been made on wrong assumptions if the issue of a dependant’s pension had not been identified. The considerations can be summarised as follows. If the client is not married, the value of a legally married spouse’s pension in the current scheme should be ignored in the transfer analysis. If the client is in a same-sex or common-law relationship, the value of a dependant’s pension should be ignored if the scheme confirms that such a pension would not be paid in these circumstances. Fine so far but more explanation is needed. I noted earlier that the value of the dependant’s pension promise must usually be included in calculating a transfer value for deferred members. I included the word “usually” as some schemes define a spouse as the spouse at the deferred member’s date of leaving service whereas other schemes define the spouse as at the deferred member’s date of death. From the perspective of schemes which use the date of leaving definition, where the member was not married at the date of leaving service – even if he subsequently marries – no spouse’s pension will be paid. A number of these schemes, if they are aware that the member was not married at the date of leaving, will not include the value of the spouse’s pension in the transfer value. In my experience, the number of schemes which go to such lengths is quite small but the transfer analyst should be aware of the possibility that there may not always be the “windfall” profit in these schemes which I have so far been discussing. Thus, the transfer analyst should also consider situations where the client was married at the date of leaving but is not married now, single at the date of leaving but now married or married at the date of leaving but subsequently divorced and married again. Confused? You should not be. The addition of a few simple questions on your client and scheme questionnaires will reveal all in a few seconds. Client questionnaires- What was your marital situation at the date of leaving?- What is it now?- Might you expect it to change in the foreseeable future? Scheme questionnaires- What is your definition of spouse (date of leaving or date of death) and attitude to a dependant’s pension in same-sex and common-law relationships? It is worth the analyst’s effort. You will find a great many instances where the client’s circumstances – past, present or future – deny any entitlement to a dependant’s pension. An increased number of people fall into one of the categories I have highlighted in this and previous articles, as the number of people remaining married to the same person throughout their lifetime continues to fall dramatically.
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