Flexibility on offer under new £100bn pension rules

Published on Friday 19 September 2008 21:52

MILLIONS of investors will have new freedom to invest over £100 billion of pension funds next month when fresh rules come into force. Under changes announced in June, protected-rights funds (see box) will be eligible for self- invested personal pensions (Sipps). Experts predict a stampede of investors taking advantage, but others fear a potential misselling scandal, with Sipps suitable only for those wanting control over their pension investments.

Some providers have already opened their doors to protected-rights Sipp applications, including Standard Life, which began accepting transfers in late August. "There's a real appetite for it and business is starting to come in," said Alastair Hardie, pensions marketing manager at Standard Life. "If you have consolidated your other pensions into a Sipp, protected-rights could be the final part of the jigsaw."

There are a few factors to think about first, however. Most importantly, understand where your protected-rights money is now and what you're giving up by transferring.

"Most money that's contracted out tends to be in with-profits or managed funds, few of which have delivered," said Tom McPhail, head of pensions research at Hargreaves Lansdown. "But if you're in a good one, or you have guaranteed annuity rates or there are penalties for moving your money out, it might not be worth moving."

It could also be worth staying put if you would lose discounts or employer contributions by transferring, while if you're happy with your pension fund performance, transferring to a Sipp would only be attractive if you want more investment choices or you believe it'll save you money. Alternatively, if you want to transfer anyway but don't want access to the wider range of investments offered by Sipps, you may be better off transferring to a competitive traditional personal pension plan, many of which offer a growing number of investment fund choices.

"Many personal pensions have a wide range of funds to choose from, without the need to invest in a full-blown Sipp, and with lower costs built in," said Eoghann McPherson, chartered financial planner at Campbell Dallas Financial Services, who believes that just one in ten of those with protected rights would benefit from transferring to a Sipp. "Most protected-rights investors should be able to create a suitable pension portfolio to suit their own risk tolerance levels with a modern personal pension plan as opposed to an all-singing, all-dancing Sipp."

But for existing Sipp investors, the convenience of having their protected rights under the same roof is a significant advantage, McPhail pointed out. "Being able to manage the protected-rights chunk of money with the same investment strategy as your other pensions makes life easier, as it's all in one place," he said.

He added that the funds available in Sipps tend to perform better, with the average unit trust outstripping the average pension fund by 12 per cent, 22 per cent and 69 per cent over five, ten and 15 years respectively, according to Hargreaves Lansdown.

The range of charges levied on Sipps is wide, with the most comprehensive Sipps – suitable only for the most sophisticated investors – the most expensive. A growing number of Sipps focus on the mainstream assets and levy far lower charges, however. Several – including James Hay, Alliance Trust, Sipp Deal and Hargreaves Lansdown – have no set-up fees, making their costs equal to or lower than those for traditional pension plans.

If you do choose to transfer your protected rights to a Sipp, the process is straightforward, requiring a simple transfer request form to be completed and confirmed. Standard Life reports that transfers typically take four weeks from the initial request. However, the pedestrian administration of many insurance companies means the transfer itself can take several weeks, so you need to act now if you want to take advantage of the new rules from the outset on 1 October.

BACKGROUND

PROTECTED-RIGHTS money is built up from contracting out of the state second pension or its forerunner, the state earnings related pension scheme (Serps).

In return for a lower state pension, investors were given a rebate of their National Insurance contributions that was paid directly into their pension scheme, generating a pot of "protected rights". A protected rights fund accumulating since 1988 – when the rebates were first paid – may now be worth up to 50,000.

But until 1 October these funds – held by around six million investors – are not allowed in Sipps, so they typically lie in insurance company funds with more limited investment options. The greater choice in Sipps includes shares, investment trusts, commercial property, exchange traded funds and shares, among others.

Opting out can provide an extra pension pot

THE idea behind protected rights was that, in opting out of the government pension scheme, people could divert contributions into investments that could make them more money than the government scheme – and save on National Insurance contributions along the way, writes Colin Hendry.

However, there is a risk in contracting out, as benefits from the government are to an extent guaranteed.

As well as the potential for higher returns, protected-rights schemes offer much more flexibility at retirement than they used to. Benefits can be taken at age 50 (rising to 55 from 2010) rather than the state pension age. Pensioners can also take a 25 per cent lump sum, while the drawdown facility can be utilised if appropriate, just as with a normal personal or occupational scheme.

However, Sipps offer more flexibility and choice as to how they invest their pension funds and how they take their benefits when they retire, but with the exception of a small number of SIPP contracts offered by a handful of life offices, it has not been possible, until now, to transfer protected-rights benefits into a SIPP.

So what should you do if you have protected rights? Firstly, it is important to talk to your adviser. Many Sipp providers are allowing the process of transferring protected rights to commence ahead of the October legislation change. Transfers can take some time to complete, so it is worth considering your options as soon as possible. You will also have to make a decision as to how to invest the additional funds after transferring them.

It is also possible to cancel an ongoing election to contract out of the state second pension. Changes to the National Insurance rebate over the years have made contracting out less attractive, so this is obviously a good time to talk to a financial adviser to discuss the various options available to you.

&#149 Colin Hendry is a director and chartered financial planner with Johnston Carmichael Financial Services