In last week's issue of Investment Week, we looked at some of the financial issues for people who ar...
In last week's issue of Investment Week, we looked at some of the financial issues for people who are considering contracting out the State earnings-related pension scheme (Serps). We concluded that, based on historical returns, those who contract out appear to have a very good chance of gaining substantially, but that this is a significant risk that some policyholder will not be willing to take.
However, the contracting-out decision does not depend just on these purely numerical issues. In this article, we will consider some of the other factors that may be relevant for clients, then draw together a few key conclusions from this short series.
One important advantage of contracting-out is that it gives more flexibility in the timing of when the pension starts than Serps. Serps benefits cannot be taken before State pension age (SPA), currently 65 for males and 60 for females. Between 2010 and 2020, however, the female SPA will rise in stages to 65. Contracted-out benefits from a personal pension can start at any time between the ages of 60 and 75, although obviously the pension is likely to be reduced if it is started before the SPA. This added flexibility could be valuable, especially for those who have substantial other provision and want to target retirement at 60.
A second possible attraction of contracting-out is that the client may be able to use a pension fund withdrawal (income drawdown) facility. But bear in mind, this is not particularly straightforward. The income limits are different from those for non-protected rights since they allow for limited price indexation (LPI currently the lower of price inflation and 5% a year). If any of the protected rights are from employment before 6 April 1997, there will be another set of income limits for these, allowing for LPI with a maximum increase of only 3% a year. It can therefore become fairly complicated, and many may prefer simply to buy an annuity with the protected rights fund, particularly if the fund is relatively small in relation to the total.
A third potential benefit arises if the individual is unmarried when they take their benefits. If they are married, they must include a 50% spouse's pension and figures on the viability of contracting-out are usually calculated on this basis.
However, for protected rights arising for service from 6 April 1997, if the individual is unmarried at retirement, a higher single life pension can be bought. This could be about 10% higher than the one with a spouse's pension. With Serps, the pension is independent of marital status.
Finally, the death benefits are different for Serps and contracting-out. This is a complex area, with many different permutations.
Proposed changes to the death benefits under Serps have caused considerable controversy over the last few years. The previous Conservative Government decided in 1986 to reduce widow's benefits from Serps where the member died on or after 6 April 2000. However, the DSS did not communicate the change effectively and the Government eventually postponed it. Less well-publicised have been the changes introduced by the Welfare Reform and Pensions Act 1999, including extension of widowers' Serps benefits on death before retirement. The following is a summary of the position for members who die on or after 9 April 2001.
l If both husband and wife are over SPA when the first of them dies, the survivor will inherit the other's Serps pension. This also applies to widows who are over SPA when their husband dies under SPA.
l If a widow is under SPA, but over 55 when her husband dies, she will receive his Serps pension when she reaches SPA as long as she has not remarried. If she was aged between 45 and 55, she will receive a proportion of his Serps pension.
l If both husband and wife are under SPA when the first of them dies, the survivor is entitled to the other's Serps pension when he or she reaches SPA provided they are over 55 at the date of death and they have not remarried before SPA. If the survivor is between 45 and 55, they will receive a proportion of the Serps pension.
l A widower will receive no inherited Serps if he or his wife is under SPA when she dies but the other is over SPA. This is due to change in 2010, when widowers will be brought into line with widows.
l Where there are dependent children (aged under 16 or under 19 and still in full-time education), inherited Serps is paid to a widow or widower at the full rate until the children stop being dependent, or until the widow or widower dies or remarries, if earlier. If the widow or widower is over 45 when the children stop being dependent, the Serps pension may restart when the individual reaches SPA.
In all cases, the total of the inherited Serps pension and the individual's own Serps pension cannot be above the maximum possible Serps pension for an individual. The 'inherited Serps' issue is to do with the maximum percentage of Serps pension that is paid to a qualifying widow or widower. The original intention was that it would reduce from 100% to 50% for deaths from 6 April 2000. When the problems emerged, the date was put back to October 2002, with special arrangements for those who could show they had been misled by the DSS. More concrete rules have subsequently been put in place. Now, those who are over SPA at 5 October 2002 will receive 100%, while those reaching SPA between then and 5 October 2010 will receive a lower percentage, but over 50%. Those reaching SPA later than that will receive 50% of their late spouse's Serps entitlement.
Fortunately, the rules for protected rights are more straightforward. The pension bought at retirement must normally incorporate a 50% spouse's pension. The exception is that if the
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