Since 2015 we have all become very familiar with the idea of ‘freedom and choice’ when it comes to Defined Contribution pension pots. But I wonder how many advisers – and in particular how many clients – are fully aware of the extent to which ‘freedom and choice’ is also available within the Defined Benefit world?
I believe there is a real risk that clients may have little idea of the flexibilities open to them to reshape their DB benefits.
Unless advisers get under the skin of the client’s DB rights, there is a risk of missed opportunities when it comes to creating the best retirement journey.
Flexible defined benefit pensions
In the past, DB pensions have been thought of as pretty rigid.
A DB pension simply paid a standard pension at a standard age.
But these days, schemes are increasingly offering members the chance to reshape their benefits in potentially attractive ways.
Three which may be of particular interest are the Pension Increase Exchange (PIE), the Bridging Pension Option (BPO) and the partial DB transfer.
What is Pensions PIE?
The idea of a PIE is that the member gives up some of his/her inflation protection in return for a higher starting pension.
This is possible because many DB pension schemes offer a higher level of inflation protection than the minimum level required by law. For example, a scheme may offer RPI increases when the law only requires CPI increases.
With a PIE, the member can relinquish increases which go over-and-above the legal minimum and in return they get a higher starting pension – sometimes substantially higher.
Some schemes have a PIE option built in to the rules of the scheme, but others run one-off PIE ‘exercises’, giving members (including pensioner members) the chance to reshape their benefits.
Although giving up inflation protection at a time of high inflation might sound counter-intuitive, demand for PIEs remains strong.
If the client believes that the current high inflation rate is temporary then they may be relatively relaxed about giving up some of their future inflation protection.
This could be especially true if they face cost-of-living pressure now and want to boost their upfront income.
What is the Bridging Pension Option?
A second DB flexibility which is becoming more popular is the Bridging Pension Option (BPO). In this case the member starts to draw their scheme pension below state pension age but at a substantially enhanced rate.
Once the state pension kicks in, the scheme pension then drops back.
This can enable someone to retire before state pension age and to have a smooth income through retirement rather than a low scheme pension followed by a jump at state pension age.
Anyone interested in early retirement and how this could be financed should be seeing if their scheme offers a BPO.
What is a partial DB transfer?
A third option is that of a partial DB transfer.
These may be particularly relevant where a member’s pension rights are heavily concentrated in a single scheme and where a full DB transfer would represent too great a transfer of risk.
A partial transfer allows the member to secure their core guaranteed income from state pension and (partial) scheme pension, and to enjoy flexibility with the transferred part.
Although only around 1 in 5 schemes currently offer partial transfers, more are actively considering doing so, and this should be on the table in any conversation about structuring income in retirement.
The growth in these ‘member options’ is driven in part by DB schemes wanting to improve their funding position and reduce their risk.
But there is a real opportunity for a ‘win-win’ in this space provided the terms of the offer are fair.
Members can enjoy greater flexibility and a pension which pays out when they need it most, whilst schemes can move closer to financial security.
Advisers can play their part in making sure that members are fully aware of their options and use those that are most relevant to their situation.
Steve Webb is a partner at consultants LCP, and was pensions minister 2010-15.
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