ReFlex
INCREASING MEMBER
CHOICE, REDUCING
DEFINED BENEFIT EXPOSURE
The burden of defined benefit (DB) pensions has never
seemed more acute than it does right now. However,
while low interest rates persist, the cost of transferring
DB liabilities to an insurer keeps this option out of reach
for many employers.
Meanwhile, members of DB pension schemes who are looking to maximise
their tax-free cash and immediate income on retirement are finding that DB’s
complexity and inflexibility does not suit their needs. For example, spouses’
pensions are usually provided – even for single members. Additionally, a typical
scheme may have up to five different tranches of pension that have different levels
of post-retirement increase (see Figure 1). These elements make it very hard for
members to understand how their pension will increase each year after retirement.
Figure 1: Increases in Overall Pension Each Year After Retirement
Tranche of pension
Typical annual increase
after retirement
Guaranteed minimum pension (GMP)
earned before 6 April 1988
No increases
GMP earned from 6 April 1988
In line with RPI/CPI subject to a
maximum of 3% per annum
Pension in excess of GMP earned
before 6 April 1997
Typically ranges from flat to
fixed 5% per annum
Pension earned between 6 April 1997
and 5 April 2005
In line with RPI subject to a
maximum of 5% per annum
Pension earned from 6 April 2005
In line with RPI subject to a
maximum of 2.5% per annum
ReFlex is a way to assist
members approaching
retirement to transfer out
of the pension scheme,
thereby reducing scheme
risk and increasing
member choice.
EXTENDING CHOICE
Increasing numbers of employers and trustees are considering a new approach
to providing retirement benefits that enables members of DB pension schemes
to reshape their entitlements to fit their own individual circumstances. This
freedom has been open to members of defined contribution (DC) schemes for
years and is made available to DB members by facilitating a transfer to a DC
pension arrangement on retirement. We call this “ReFlex”: retirement flexibility.
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ReFlex needs to be distinguished from enhanced transfer value (ETV) exercises
in two ways. First, ETVs are typically offered to deferred pensioner members
who are then subject to investment risk between the dates of taking an ETV
and reaching retirement. However, ReFlex applies on retirement, so members
are not subject to any pre-retirement investment risk. Furthermore, while
benefits under ReFlex are provided in a DC arrangement, they are based on
guaranteed annuity quotes, so in terms of risk and benefit provision ReFlex
closely resembles a DB to DB transfer.
Secondly, ETVs are typically carried out as one-off exercises whereas ReFlex is
a long-term change that becomes woven into the scheme’s benefit structure
(as much as the option to commute part of a member’s pension for a cash lump
sum). That means that all future retirees would automatically be able to benefit
from ReFlex.
REFLEX FROM THE MEMBER’S VIEWPOINT
ReFlex opens up a number of attractive options for members retiring from DB
schemes. Figure 2 illustrates how members can benefit from a larger tax-free
cash sum and larger initial pension under ReFlex than from their DB scheme.
Figure 2: A Typical Member’s Benefits in a DB Scheme and Alternative Options with ReFlex
Benefits in DB scheme
Alternative options under ReFlex
Cash + residual pension
Pension only
choice of
Non-increasing
annuity of
£12,000 pa
with 50%
spouse’s pension
Increasing pension
£10,000 pa
Non-increasing
annuity of
£13,500 pa to
member only
choice of
Tax-free cash
£50,000
Increasing pension
£7,000 pa
Tax-free cash
£65,000
Non-increasing
annuity of £9,000
pa with 50%
spouse’s pension
Non-increasing
annuity of
£10,000 pa to
member only
Larger Tax-Free Cash Sum
Under ReFlex, members can take 25% of their transfer value as a tax-free lump
sum. This is often greater than the amount they could take from their DB scheme.
Choice of Annual Increases
Some members want their pension to have a degree of inflation protection,
while others prefer a higher initial pension with no increases. In fact, the vast
majority of members retiring from DC schemes opt for a non-increasing pension.
ReFlex gives DB members the same choice. Even if they do want some inflation
protection, members can opt for a single rate of increase rather than the
complex and confusing array set out in Figure 1.
Choice of Spouse’s/Dependant’s Pension
Some members will want a proportion of their pension to continue to a spouse
or dependant on their death, but this is unnecessary if they have no dependants.
Equally, some members will have a spouse who has pension entitlements of his
or her own. Other members may want a pension to be payable on their death to
a dependant who is not covered by their DB scheme’s rules.
2
ReFlex allows members to choose whether to buy a dependant’s pension, the
amount of the pension, and the beneficiary of the pension. Those who do not
require a dependant’s pension can benefit from a higher pension for themselves.
Choice of Guaranteed Period
DB schemes typically provide for members’ pensions to be payable for a
minimum of five years. Under ReFlex, members can choose whether they
want such a guarantee and, if so, for how long.
Access to Impaired Life Annuities
Some members may have health issues or a history of smoking that is likely to
reduce their life expectancy. Through ReFlex, such members can apply for an
“impaired life” annuity, which pays out a higher annual amount in recognition
of this reduced expected life span.
Access to Flexible Drawdown
Members who have a secured annual income of at least £20,000 from most
sources (including State pensions) can use ReFlex to draw down their retirement
funds at a rate that suits them, including the option of taking it all as a cash lump
sum (subject to tax on the excess over the first 25%). Those who do not meet the
£20,000 test can still benefit from capped drawdown, which also provides a
degree of freedom – although less than under flexible drawdown.
WHAT REFLEX MEANS FOR EMPLOYERS
Each time a member takes advantage of ReFlex, his or her benefits are transferred out
of the DB scheme. The result is a reduction in the employer’s exposure to DB risk.
The financial impact of ReFlex on employers will depend on the relative levels of the
scheme’s transfer values and funding liabilities, and the employer’s pensions
accounting assumptions.
Figure 3: Value of £10,000 Per Annum of a Member’s Pension with Attaching 50% Spouse’s
Pension and Fixed 3% Per Annum Increases in Payment
Example liability values at age 60 for a sample member
1
350,000
}3
300,000
1
250,000
3
}2
2
200,000
150,000
100,000
50,000
Technical
provisions
Transfer
value
IAS 19
Buyout
3
Figure 3 shows the differing liability values on various basis for a typical pension
scheme offering ReFlex with no transfer value enhancement. Gap 1, between the
technical provisions (funding) and transfer value bases, drives the funding saving.
In this case, the funding saving is less than 5%. Gap 2 shows the IAS 19 accounting
impact. The IAS 19 value is around 80% of the transfer value here so it would
have a balance sheet impact, although this will emerge as members retire and
therefore would normally be immaterial in any one year. Gap 3 shows the
typical buyout saving that would be achieved. In this case it is around 20%
of the buyout liability.
Some analysis is required to find the ideal balance between:
• Saving: whether the offer to members is “cost neutral” or whether some
level of saving is sought (and, if so, saving against what measure?)
• Cost: possibly topping up transfer values to make ReFlex even more
attractive to members
• Outcome: the desired level of take-up and resulting reduction in
DB exposure
An employer implementing ReFlex may wish to carry out an exercise to allow
active and deferred members aged 55 and over to draw their retirement
benefits immediately (possibly while carrying on working). This could get
ReFlex take-up off to a flying start.
TRUSTEES’ AND THE PENSIONS REGULATOR’S
VIEW OF REFLEX
The Pensions Regulator has updated its guidance on arrangements such as
ReFlex and now mainly relies on compliance with the pensions industry’s
“Code of Good Practice” for such arrangements. The Code, published in June
2012, does not present any barriers to ReFlex and both trustees and employers
will need to comply with it.
Members already have a statutory right to take a transfer value up to a year
before their normal retirement age; ReFlex simply extends that right and
further increases member choice and flexibility. ReFlex also makes the process
easy for members, for example, by presenting ReFlex options alongside the
normal scheme options of pension or cash and reduced pension, and by
obtaining competitive annuity quotations.
In addition, to the extent that ReFlex reduces the employer’s DB risk, it
should also be positive for the covenant.
ReFlex is therefore a win/win option for trustees and members as well as
for employers.
IMPORTANT NOTICES
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discussed. Past performance does not
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NOT INVESTMENT ADVICE
This does not contain investment advice
relating to your particular circumstances. No
investment decision should be made based on
this information without first obtaining
appropriate professional advice and
considering your circumstances.
INFORMATION OBTAINED FROM THIRD PARTIES
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from a range of third-party sources. While the
information is believed to be reliable, Mercer has
not sought to verify it independently. As such,
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as to the accuracy of the information presented
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CONTACTS
Matthew Demwell
[email protected]
+44 20 7178 3294
Patrick Lloyd
[email protected]
+44 20 7178 3100
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