Contracted in money purchase schemes look to be back in style as an increasing number of large employers close their defined benefit schemes to new members and look for plans with similar features
By the late 1990s, many advisers had written off the contracted in and contracted out money purchase scheme (CIMP/COMP) as an anachronistic product that could not compete with the simplicity of group personal pensions (GPPs). Following the introduction of stakeholder schemes this year, even GPPs have felt the pinch, and providers have slashed charges across the board to maintain their competitive edge. What hope then for the rather complicated and widely misunderstood CIMP in this brave new world?
Surprisingly, CIMPs are alive and well and look set to make a comeback as an increasing number of employers close their defined benefit (DB) scheme to new members and install a money purchase occupational scheme ' a step that big employers such as BT have already taken. Larger employers like the fact that a CIMP, as an occupational scheme, mirrors many of the features of the traditional DB scheme, including a board of trustees responsible for looking after the members' rights and benefits.
COMPs and CIMPs are more complicated than GPPs, however. These are Inland Revenue-approved occupational pensions and, as such, will follow the same contribution and benefit limits as final salary schemes. The maximum employee contribution is 15% of salary (restricted for employees affected by the earnings cap). Maximum contributions and benefits are expressed as a proportion of salary, but where the pension is guaranteed by the employer in the case of the DB scheme, with an occupational money purchase scheme it depends on the level of contributions, the fund size at retirement and prevailing annuity rate ' just as it does with a personal pension.
These rules can be very confusing for employees, who may see the maximum benefits as a guarantee, and for this reason it is vital the scheme's literature explains the benefit calculations clearly.
Despite these complexities, these schemes have several distinct advantages for employees. Rodney Jagelman, director of corporate affairs at consultant Gissing, says: 'As a type of occupational scheme, COMPs and CIMPs tend to be fairer than GPPs, as the employer is likely to bear the administration charges, leaving the employee to pay for only the investment management and any transfers.'
Martin Reynard, pensions manager of chartered accountant Blick Rothenberg, adds: 'It may also be possible to take a larger proportion of the COMP/CIMP fund as tax-free cash than is possible with a personal pension, where the lump sum is restricted to a maximum of 25% of your fund.'
Under a CIMP, the tax-free cash typically builds up at the rate of three-eightieths of final salary for each year of service.
FEEs on existing plans
In the revival of the CIMP market, it is important to distinguish between these larger and more generous schemes, usually established on a self-administered basis, and the cheap and cheerless versions many smaller employers bought in the late 1980s and early 1990s. Most of these sales were motivated by the high rebates of National Insurance contributions and incentives the Government made available to encourage contracting out.
Some of these insurance company packages and the early GPPs may still incorporate high charges and exit penalties. Several insurance companies ' Standard Life and Norwich Union, for example ' have reduced charges on all their personal pension products to bring them in line with their low-cost stakeholder scheme.
Standard Life's charges on individual plans and GPPs, for example, are between 0.6%-0.825% ' well below the 1% maximum under stakeholder. However, at the time of writing, Standard Life was the only company to announce plans to reduce charges on its CIMPs. These will apply from February 2002.
Reynard says: 'Small- to medium-sized employers often use off-the-shelf insurance company pension schemes. Many such providers have cut the cost of personal pension products in the light of stakeholder scheme charges, but have been much slower to do so on corporate products. In most cases, it really is unnecessary to pay more than 1% per year of funds under management. Employers and employees alike should be taking a close look at charges on existing schemes.'
If other insurers follow Standard Life's lead then we could see a revival of the insured product. Barry O'Dwyer, marketing development manager at Standard Life, says: 'In the past, the self-administered route looked more cost-effective for the larger employer, but with the price of insured CIMPs coming down substantially, these products could prove the more popular option in future. Where the employer uses fee-based advice the annual charge should be less than 1%.'
By April 2002, the rebate terms will have come a full circle and will not be worth the trouble for most money purchase schemes. For this reason, employers with comps are almost without exception converting to CIMPs.
'This is a relatively easy process,' says Jagelman. 'However, it does leave employers with a rump of protected rights funds to manage.'
If your corporate clients do make the switch, this will leave individual employees to make the choice whether to opt out or stay in the State Second Pension (SSP) which replaces Serps next April. Employees can contract out using an appropriate personal pension and this does not affect their right to membership of the occupational scheme.
Making that decision will not be easy though, and advisers may find their workload increases if corporate clients recognise this dilemma and offer to pay for one-to-one counselling or group seminars on contracting out.
The problem here is that the calculation to determine whether an individual should be in or out of Serps/SSP requires so many assumptions ' including falling investment returns and annuity rates ' that it is more of an art than a science. Since its inception in 1978, the value of the Serps pension has been reduced on several occasions. A few years after its launch, the SSP will change from an earnings-linked pension to a flat rate benefit. No wonder people are confused.
Unfortunately, the calculations will become even more complicated when less favourable rebate terms are introduced in April 2002.
'Despite strong representation from the pensions industry, the Government's new rebate terms fail to reflect the outlook for lower investment returns and interest rates,' says Paul Greenwood, head of retirement research at consultant William M Mercer. 'The result is that contracting out will no longer be a financially attractive option. The new rebate terms could spell the end of contracting out for money purchase schemes and stakeholder pensions,' he says.
As corporate clients review their existing occupational money purchase schemes, this will be a good time to recommend an increase in both the employer and employee contribution. William M Mercer suggests that a 15%-20% total employee/employer contribution rate is appropriate in the current economic climate, where investment returns are falling and the cost of buying an annuity is rising.
Employers should also be encouraged to provide pension projections on a regular basis to help employees keep on target, the consultant says.
CIMPs are enjoying an unexpected revival.
Advisers should review charges and terms on existing CIMPs.
Employees will need individual advice on contracting out.
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