Michael Smith gives the lowdown on investing protected rights funds in SIPPs
After much anticipation, on 29th July 2008 regulations were set by the Department of Work and Pensions (DWP) allowing self-invested personal pensions (SIPPs) to hold protected rights (PR) from 1st October 2008.
'Protected rights' are funds built up in money purchase pension schemes from National Insurance rebates when an individual has contracted-out of the State Second Pension (S2P, formerly called Serps).
The DWP consultation response of 27th June 2008 discussing this change can be viewed at www.dwp.gov.uk/publications/dwp/2007/occ-pen-consult/govt-resp-ppsaspraregs08.pdf.
The change will remove the current restrictions on investing in PR and therefore will give greater choice over where individuals can invest their pension savings.
To accept PRs, a personal pension (PP) must be what is called an 'appropriate personal pension' (APP). Appropriate personal pensions must be registered with HMRC and meet certain criteria.
DWP Regulations currently restrict what type of organisation may set up an APP. More importantly, they limit what 'form' an APP set up by a particular type of institution may take (i.e. what form the underlying investment may be).
For example, an insurer may set up an APP, but the underlying investment for each member's scheme must be an insurance contract (i.e. it must be a scheme for the 'issue of insurance policies'). Similarly a bank may set up an APP, but all the PRs must be held in bank accounts. It is not permitted to mix and match investments between the allowed 'forms'. A unit trust provider, say, cannot set up an APP investing in insurance policies (only their own unit trusts), and equally an insurer cannot set up an APP invested in unit trusts.
A number of insurers have set up an APP where effective self-investment has been offered through the 'vehicle' of an insurance policy. So the underlying investment is an insurance policy with the provider, but the member can direct how the funds within the policy are invested.
The above has meant that members of different APPs have had different underlying investment restrictions, and puts providers not linked to an insurer at a disadvantage. So you can not currently self-invest PR with a specialist SIPP provider, but you effectively can through some insurance companies' APPs.
What is changing?
Now that SIPP operators are regulated by the FSA, the DWP is prepared to lift the current investment restrictions. The regulations are short and sweet. They remove most of the two clauses that limit who can establish an APP and what form particular APPs must take. The effect will be that PRs may be held in a SIPP and allowed full self-investment (subject to HMRC rules of course). As we read the Regulations, PRs will have the same self-investment scope as Non-PRs now.
So direct investment in stocks/shares and commercial property will be permitted, as well as the more specialist investments such as collectives, mutual funds and unquoted investments (subject to the SIPP provider's own restrictions). Full borrowing against PRs will be possible too.
Segregation and 2012
SIPPs will still have to track PRs separately from any Non-PRs. There are still a number of DWP restrictions that apply to PRs that will remain after October.
For example, there is a requirement to buy a spouse/civil partner a 50% joint-life annuity when you buy an annuity, use unisex annuity rates and use funds on death to provide a spouse/civil partner's pension (annuity/income withdrawal) where such a survivor exists. This clearly is not ideal.
In the long-term, Pensions Act 2007 provides for the abolition of contracting-out on a defined contribution basis (including an APP) from, it is proposed, April 2012 (the 'abolition date' has not been appointed yet).
The intention for 2012 seems to be to erase all the differences between PR and Non-PR, in which case the respective funds can all then be merged (making things much simpler). One of the final stumbling blocks was the PR death benefit restrictions, which were not covered by the abolition clauses in the Act.
DWP was initially undecided here, but has now confirmed it intends to amend the Pensions Bill to remove this requirement at 'abolition date'. There are still a few unanswered issues (for example, if after 'abolition date' a member transferred back to a contracted-out defined benefit scheme would a guaranteed minimum pension (GMP) split be needed?), but the signs show segregation will no longer be necessary come April 2012.
SIPP systems should be able to cope with segregation (under the old tax regime transfers in from occupational schemes required segregation, as we do now with income withdrawal transfers).
Appropriateness and FSA projections
The logic behind the existing restriction of PR investment was that these funds were to replace part of your state pension - as such 'safe' investments were enforced to try to ensure, as much as possible, that those PRs did end up providing a broadly similar entitlement in the end. Of course, things are never quite that straightforward.
The relaxation only comes on the back of the increased security the regulation of SIPPs provides. A SIPP is not suitable for everyone, and an adviser still needs to be satisfied on the 'appropriateness' of a particular SIPP for an individual. As the DWP noted in its original consultation, 'SIPPs provide a useful option for some people'.
The FSA has emphasised that an adviser must be satisfied that a SIPP 'reflects the customer's needs, priorities and circumstances' where recommending a particular SIPP for contracting-out purposes.
It has also confirmed that where a member wants to contract-out on an ongoing basis (i.e. accept rebates) the member must be provided a contracting-out comparison, as existing APPs currently must do. This requirement would not be covered by the existing FSA SIPP exemptions. The comparison allows the member to compare the S2P given up with the potential return under the SIPP.
There are clearly costs in SIPP providers sourcing a system that provides the required comparison (to FSA specification) if they currently do not have that capacity. Given that contracting-out will be abolished in a few years time, those without the required system may well only allow the transfer in of existing PRs as a projection is not required in this circumstance (unless the member is going into income withdrawals).
So while it is an exciting time out there for SIPP providers there are still a number of issues that need to be considered. While the change opens the door for SIPPs to enter a potentially huge new market, advisers still need to ensure they only recommend a SIPP for those clients with PR where truly appropriate (and suitable underlying investments).
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