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With this survivor&#39s pension, I thee wed

Over the last few weeks, I have been looking at the objective and subjective factors used in determining whether an individual with a preserved pension in a defined-benefit scheme should effect a transfer to a personal pension or pension buyout bond.

The particular relevance of this series of articles at this point in time is that the flow of employers closing their final-salary schemes in favour of money-purchase alternatives is now developing into something of a flood. The reasons for this trend are well documented and there seems little possibility that we will not now see many more millions of employees – and not just early leavers – with preserved pension arrangements.

So far, I am still only discussing key issues in the first out of four, or sometimes five, stages in calculating a transfer value. The first stage involves the quantification of accrued benefits (member&#39s pension and death benefits, including dependants&#39 pensions) within the scheme.

As regards dependants&#39 pensions, I started to look last week at key issues relating to each scheme&#39s definition of a legally married spouse. This is much more complicated than it seems, with many implications for potential transfers of pension rights away from the existing scheme.

Yet the situation relating to unmarried couples is even more complex. As regards common-law partners – that is, unmarried couples of the opposite sex – it is worth noting that the National Association of Pension Funds&#39 2000 survey reveals that, although around two-thirds of private-sector schemes will consider paying a pension to a surviving common-law partner, only around one-quarter of public-sector schemes give the trustees such discretion. Thus, three-quarters of these schemes categorically deny a pension to any partner other than a legally married spouse.

It is important to note that, even among the more broad-minded schemes, very few state that they will always pay a pension to a common-law partner. This is understandable. There is no legal definition of a common-law partner, so pension scheme trustees are given discretion as to whether or not to pay a claimant, considering such aspects as the number of years the couple have been living together, whether they have joint financial commitments such as a mortgage and whether or not they have dependent children.

What does all this mean for the assessment as to whether a client should effect a transfer of preserved pension rights? Simply, if that client is not legally married and has no intention of becoming so, he should be aware that no surviving spouse&#39s pension will be payable from schemes which will not consider paying such a pension to anyone other than a legally married spouse.

The transfer analysis should therefore (at least arguably) be processed as if the scheme benefits consist only of a single-life pension, except where there are dependent children. This will result in a much lower critical yield than would otherwise be the case.

This will, in turn, result in many more people being recommended to transfer. In summary, the client fact-find should identify not only whether the client is in a common-law relationship but also whether that situation might be expected to change in the foreseeable future.

This fact-find requirement is even more important for homosexuals. The aforementioned NAPF survey indicates that only around half of all private-sector pension schemes – and less than one in five public-sector schemes – will consider paying a pension to a surviving same-sex partner.

You should immediately be able to see the relevance of these statistics for pension transfer analyses. If a homosexual client has a preserved pension with one of the significant majority of schemes which categorically refuse to pay a pension to a same-sex partner, this is a strong motivator to effect a transfer to a private pension arrangement under which the client has total discretion as to who to nominate for death benefits.

So, to summarise our discussions of the last couple of weeks, the adviser must identify from his client:

Not only if he is currently legally married but also whether he was legally married on the date he left his former pension scheme.

If the client is in a common-law or homosexual relationship, was he or she legally married on the date of leaving the former pension scheme?

In all cases, does the client foresee his marital status changing in the foreseeable future, for example, is he anticipating a future marriage or divorce?

The adviser, in enquiries to the scheme, must identify from that scheme:

On the assumption that a pension would be payable to a surviving legally married spouse, is that pension payable to the spouse at date of leaving service or the spouse at date of death?

Whether a pension would be payable to a surviving common-law partner.

Whether a pension would be payable to a surviving same-sex partner.

By then comparing the client&#39s past, present and expected future marital situation and the scheme eligibility rules for the payment of a survivor&#39s pension, the adviser can then ensure that he is neither undernor over-representing the value of the death benefits from the existing scheme. This will give a more accurate assessment of the potential value – at least as far as death benefits are concerned – of a transfer to a personal pension or a pension buyout bond.

At the end of stage one in the calculation of a transfer value, therefore, we have identified the value of the member&#39s pension (remembering, from a couple of weeks ago, our discussion regarding the relevance of state scheme offset) and of the surviving spouse&#39s pension. Nothing, as we have seen, should be taken for granted.

That brings us to the next stage of the calculation, where there are equally important messages for pension transfer advisers. At stage two, the preserved pension, including the value of the death benefits, is revalued to the scheme&#39s normal retirement age. This requirement for revaluation explains why the regulators strongly discourage us from using the terminology “frozen pension”, much preferring the more technically accurate term “preserved pension”. Thus, the client&#39s preserved pension will grow in value each year within the scheme. But at what rate?

It has been a widely held view, ever since I have been active in pension transfers, that the maximum possible level of security and guarantees is gained by leaving preserved pension benefits with the existing scheme.

Risk, it has always been believed, is introduced only when considering a transfer to a private pension arrangement. How true is this?

Consider, before next week, the fact that the vast majority of preserved pension benefits are set to be revalued in line either with price inflation or earnings inflation.

Stages in calculating a transfer value

1. Identify the value of the preserved pension.

2. Revalue to the scheme&#39s normal retirement age.

3. Quantify the lump sum required to buy the revalued pension.

4. Discount the lump sum from the third stage to the current date.

And, possibly:

5. Adjust for current investment market conditions.

Keith Popplewell is managing director of Professional Briefing

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