Individuals contracting out of the state second pension (S2P) scheme could find themselves with £4 per week less than if they remained within the scheme, sparking a possible investigation into mis-selling claims by the Financial Service Authority (FSA).
The City watchdog says it has found the majority of individuals who contracted out of the S2P or the older state earnings related pension scheme (Serps), and put their tax rebate into a personal pension, will face shortfalls in their returns.
Research conducted by Oxford Actuaries and Consultants, on behalf of the City watchdog echoes research published last week by consumer association Which?, warning the 4.5m people currently contracted-out they would be around 20% worse off than if they remained in the state scheme.
OAC finds those individuals contracting-out of the state scheme at various times since 1998 and remaining contracted out until 2005 would lose about £4 per week or £4,000 from their pension pot, while those individuals contracting out for a five-year period and then contracting back in would lose an average of about £2 per week at retirement.
The OAC cautions results show a wide range of potential outcomes depending on when consumers contracted out, at what age they did so, the period for which they were contracted out and the performance and charges of the personal pension fund they invested in.
The FSA says close to eight million Brits have been contracted out of the S2P or SERPS in the past, while three million people were currently contracted out.
Moreover, while the regulatory body notes the importance of not directly equating a potential underperformance with mis-selling, it warns in its report:
“The likelihood that significant numbers of consumers may face relative underperformance at retirement as a result of having contracted out of the additional State Pension does make it important that we consider whether there has been any significant mis-selling.”
The FSA says it has contacted several product providers and advosory firms to discuss how industry practice has progressed.
It adds discussions with Financial Ombudsman Service over contracting out complaints by individuals, has so far been as few as 100 cases.
Responding to the research, a spokesperson at the ABI says: "The FSA's research backs up our own view that contracting-out is currently over-complicated. However, the system has the potential once again to be a vehicle for stimulating private saving, which is why we have urged the Government to simplify and promote contracting-out.
"The FSA are right to point out that it is an individual decision on whether to contract in or out, which people should review annually," continues the spokesperson.
The ABI says it will await the outcome of additional work by the FSA on any mis-selling claims, mentioning the risk involved for those individuals contracting in or out, adding:
"In the former case, one is making a judgement on whether the Government will fulfil at some point in the future promises it has made now, and in the latter, whether industry will provide investment returns."
John Lawson, marketing technical manager at Standard Life, says the FSA work is not surprising given its watchdog responsibility to ensure advisers and providers react in the right way to changing market conditions.
“I agree with the FSA that there has been a change in the balance of risks over the last 2-3 years. That is why providers such as Standard Life, supported by the ABI, have been taking a very proactive approach to encouraging those who could be adversely affected by taking on unacceptably high levels of risk (to a high proportion of their income in retirement) to contract back into S2P.”
He, however, argues the Government Actuary’s Department has failed to react to changing market conditions by increasing rebates, despite calls from the industry to do so.
Lawson concludes: “The industry has been taking a very responsible approach to the contracting-out issue for some time now and I would be surprised if the FSA subsequently found that there had been a significant level of mis-selling.”
Rachel Vahey, manager of pensions development at Scottish Equitable, believes the FSA will approach the issue with a balanced view pointing out the few number of complaints about contracting-out raised by individuals.
Norwich Union says it is in the process this week, of sending out letters to 40,000 clients who are not attached to financial advisers, to inform them they will automatically be contracted back into the S2P, unless they are specifically told otherwise.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Gareth Vorster on 020 7968 4554 or email [email protected].IFAonline
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