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Ins and outs

The debate on whether people are better off contracting back into the S2P has been keeping many an actuarial expert awake in recent years.

I read that John Lawson at Standard Life is the latest to suggest that most people would be better off contracting back into the state system because generous rebates that the Government introduced to encourage people to opt out of the system in the late 1980s have long since been cut.

Not surprisingly, these lower rebates have made it increasingly attractive to opt back in to the state scheme, irrespective of age and sex. It is compounded because much of the £100bn of contracted-out pension plans are also invested in dismal managed funds or with-profits funds which have low equity weightings that are stifling projected returns. In short, the odds on S2P being worth more than a contracted-out pension in the future have shortened considerably.

But the decision is not always clear-cut – it is what Legal & General has long termed “soft issues” and I know several people who are more than happy to stay out. There are sound reasons to stay out if you can afford to. For instance, there are many people who understandably do not trust the Government to deliver the goods on S2P or whether the rules on the second pension will be changed again at some point in the future.

The other advantage for remaining outside the state scheme is that you can take up to 25 per cent of the contracted-out pension as a tax-free lump sum.

Naturally, for those that are contracting out, it makes sense to invest in a fund or asset that gives them the opportunity to maximise their chances of beating the Government’s intended payout.

We have been able to invest in some top-performing trusts as most pension providers offer external fund links. Scottish Widows, for example, allows people to put their contracted-out investments into leading funds from Fidelity and Invesco Perpetual.

Legal & General’s portfolio plus Sipp gives access to 250 of the most popular funds on the Cofunds platform but only people who have decided to contract back in can get access to this service because the Sipp arrangement cannot take ongoing payments so if you are remaining contracted out, you must take your money elsewhere.

I recall a Sunday Telegraph article in 2006 that rammed the point home. It highlighted the case of Mark Dampier, the high-profile financial adviser with Hargreaves Lansdown. He had seen his contracted-out pension fund almost double to £76,000 after receiving £39,000-worth of rebates since contracting out in 1988, thanks mainly to his decision in 2000 to invest the majority of his pot in Neil Woodford’s Invesco Perpetual highincome fund, which has risen by 118 per cent since. He tells me that his pot is now worth around £100,000.

A trusty Telegraph case study also showed the darker side of contracting out. Malcolm Coles, the editor of, reckoned he had made one of his worst decisions ever when he contracted out with Scottish Equitable in 1993 and remained with it until 2004.

He paid contracted-out rebates totalling £11,919 into Scottish Equitable’s balanced managed fund and by April 2005 the fund was worth only £12,587. Assuming a 7 per cent return until the day he retires at 65, he will now get an annual income of just £1,218 compared with the £2,029 he would have got by staying in the state scheme.

It shows that having greater flexibility to invest a contracted-out pot makes sense and it is why the proposal to allow protected rights funds to be held within a Sipp is to be welcomed.

We have been here before, of course, when the idea was first mooted in 2005, only to be rebuffed. But now it looks increasingly likely that the rules will be relaxed later next year, giving those that wish to stay out of the state system the freedom to invest in shares, commercial property, investment trusts or unit trusts. That is good news for those savvy investors or for those who can afford to take more of a punt. But the majority of people who are less inclined to monitor investments may want to follow Lawson’s advice.

Paul Farrow is money editor at the Sunday Telegraph


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