Government movement towards Alan Pickering’s mantra: “A pension is a pension is a pension” has often been slow but the differences between the many types of pension are gradually being removed. Probably no area has attracted more attention than protected rights under personal pensions for clients who have contracted out of the state second pension.
The changes fall into two broad categories – those that have already happened and those that the Government is considering implementing. I will look at key elements of both in turn.
When protected rights were established in 1988, the pension had to increase each year by at least the lower of 3 per cent and price inflation (known as limited price indexation). The percentage rate was increased to 5 per cent for contracting out after April 1997, again with a maximum of price inflation, but the requirement was abolished completely from April 2005. There is now no requirement for protected rights pensions to increase in payment.
A-Day saw further significant changes. Protected rights pensions can start from the same age as other pension benefits, which reduces the minimum age from 60 to 50 (55 from April 2010). In addition, 25 per cent of the protected rights fund can now be taken as a tax-free lump sum at retirement.
However, where a client has a protected tax-free cash entitlement, the protected rights element is not on top of that. The protection is based on the total tax-free cash entitlement before A-Day and the protected rights are included in that even though the entitlement for them was then zero. Also, most experts agree that when protected rights are passed to an ex-spouse on divorce and become safeguarded rights, these are not available until age 60 and still have no entitlement to a tax-free lump sum.
Turning to the changes that the Government is considering, most are designed to increase flexibility in the form of pension taken.
Currently, clients who are married or in a registered civil partnership when they start to draw their protected rights pension must include a survivor’s benefit of at least 50 per cent of their own pension. All protected rights pensions must also be calculated using unisex annuity rates, whereas annuity rates for other pension benefits are invariably different for males and females.
These and other differences are being considered in the Government’s review of open market options for annuities, which is due to report back by the end of 2007.
The expected, though not yet certain, outcome is that all differences will be scrapped and the Government has included powers to do that in the Pensions Bill.
Finally, there is the thorny question of investment of protected rights. The Government has looked several times at this issue without convincing itself that the benefits will be sufficiently secure in a Sipp environment. The next checkpoint is likely to be a review following the introduction of Sipp regulation, which in practice may mean at the end of the transition period in November 2007. Until then, the required disclosure standards for Sipps are considerably lower than for insured personal pensions.
There is still no certainty that investment restrictions for protected rights will be removed or any timetable. The powers included in the Pensions Bill would cover investments, too, and it is possible that changes to protected rights investment options will come in at the same time as the relaxations on the pensions bought.
That could potentially be as late as 2012 although it may be sooner.
So what can be done for clients in the short term?
Where the form of pen-sion benefits is a really big issue, which is likely to be relatively rare, it may be possible to defer buying an annuity with the protected rights, either by delaying drawing pension or by using unsecured pension (drawdown) initially.
In the more common situation where wider investment choice is desirable, this can be achieved through a contract of insurance, sometimes known as a private managed fund. Where self-investment is on this basis, it is already fully regulated and able to accept protected rights benefits.
Ian Naismith is head of pensions market develop-ment at Scottish Widows