August 2008

Freedom of choice

One of the most eagerly awaited pieces of pension legislation in 2008 is likely to be the Personal Pension Schemes ((Appropriate Schemes) (Protected Rights) (Amendment)) Regulations 2008. The regulations are likely to be made by the department of work and pensions in July 2008 with a view to coming into effect on 1 October 2008 and will finally allow SIPPs to accept protected rights funds.

So, let's just have a quick recap on protected rights.

Prior to 1988, contracting out of state earnings related pension scheme (SERPS) was only possible at scheme level, hence the existence of contracted in and contracted out schemes.

The introduction of personal pensions brought with it the opportunity to contract out on an individual basis. The theory was that redirecting the national insurance (NI) rebates into an individually designated plan with a range of investment funds would produce a benefit greater than the state scheme would have produced. The funds derived from these NI rebates plus 'bribes' from the state are known as protected rights. The amounts involved were relatively small.

These sums were enhanced when the Pensions Schemes Act 1993 introduced the concept of 'Section 9 (2B) Rights', so that where benefits are transferred from a contracted out final salary occupational scheme to a personal pension scheme, all benefits in respect of post 5 April 1997 service will be classed as Section 9 (2B) Rights. Such benefits must be treated as post 5 April 1997 Protected Rights.

So, with almost 20 years since inception and the boost produced by 9 (2B) Rights, we now have a situation where protected rights funds can be significant sums.

Growth of personal pensions

Finally, after a number of years, the new regulations give protected rights under personal pension schemes the same investment freedom as SIPPs.

This is a welcome reform for many reasons including simplification and investment allocation; however there is one interesting omission - small self-administered schemes (SSASs).

SSASs are occupational schemes and are outside of the scope of the regulations. In order to be able to invest protected rights, such schemes must be able to satisfy the conditions that currently apply to contracted-out occupational schemes. Consequently, the changes in the regulations will not enable small self-administered schemes to invest protected rights.

The stated aim of pension simplification at A-Day was to 'condense' the existing eight pension regimes into one. This has not totally happened and, due to these differences, there is still a market for SSASs alongside the growing SIPP market.

That being said, I am not sure that this omission will make much difference. As occupational schemes, SSASs have always been able to contract-out of the second state pension, but very few have. This is generally down to the complexity of administering contracted-out schemes and the onerous requirements regarding contracted-out benefits. Generally, contracted-out pension schemes were seen as being suitable for larger employers, not for top-up schemes for directors of small companies - the normal SSAS market.

Although not strictly part of the scheme, members of SSASs can still hold protected rights by using an appropriate scheme alongside the SSAS.

Potential issues

One potential issue created by the omission could be a limitation to the amount that a SSAS can borrow. Since A-Day, the maximum borrowing for pension schemes is an amount equivalent to 50% of the fund value - therefore the higher the fund the greater the borrowing. SIPPs will now be able to aggregate any protected rights with non-protected rights when calculating their maximum amount of borrowing.

There are still some differences between the SIPP and the SSAS regime that make a SSAS attractive - the ability to make a loan to a connected company, having the directors of the company as trustees as opposed to an unconnected SIPP trustee, the attractions of scheme pension, a common investment fund, and even costs if there are several members.

These attractions will still exist even after the changes to the protected rights legislation and I am sure that a SSAS will still be the choice for many small companies who want control of their pension schemes.

Mike Morrison
Pension Strategy Manager
Winterthur Life