Mary Stewart assesses who will be the winners and losers in the new Protected Rights landscape
Should the changes to Protected Rights rules from 1st October be given three cheers or a chorus of boos? The answer to this question depends on whether you are a saver, a SIPP provider or an insurer already sitting on many millions of pounds.
By allowing Protected Rights to be invested in trust-based SIPPs for the first time, the Government has removed an anomaly and potentially opened the floodgates for a major migration of pension assets.
It is estimated that there is as much as £100 billion in Protected Rights cash with some individuals sitting on pots worth £50,000 or more. These sums have predominantly been built up since 1988 by contracting out of the State Earnings Related Pension Scheme (SERPS), renamed State Second Pension (S2P) either individually with a personal pension, or collectively by a contracted-out pension scheme.
In return for giving up part of the state pension, a lower level of National Insurance was paid. For individuals, National Insurance rebates from contracting out were restricted to certain investments, typically insurance company funds. For schemes, Protected Rights are more of a notional sum, which only come into existence if a member transfers their benefits into an individual pension.
The key point, though, is that the rule change will allow Protected Rights funds to be held in trust-based SIPPs, a change likely to produce winners and losers in the industry.
Who could win?
We believe the big winners will be the pension savers who can take advantage of the greater investment freedom they will enjoy. Large Protected Rights funds will often be held by higher earners who have been contracted out for many years. These individuals will often be the kind of sophisticated investors who can make full use of a SIPP's investment flexibility.
These individuals can transfer their Protected Rights from old plans into a SIPP, enabling them to incur only one set of charges and offering the ability to follow a single investment strategy for all their pension arrangements. This kind of consolidation will make pension saving more efficient, leading to a larger eventual pension.
The idea that investing in a SIPP is riskier than using life office funds does not stand up to scrutiny and this is one reason why the investment restrictions on Protected Rights are being removed. With proper advice from a financial adviser or wealth manager, a diversified SIPP portfolio should be as secure as assets held in a narrow fund range with a life office.
For individuals with a SIPP holding commercial property, the incoming Protected Rights could be used to pay off, or reduce, any outstanding mortgage on the property in the SIPP. The credit crunch has made paying down debt relatively more attractive, and we expect to see many clients do this, paying in sums of perhaps £30,000 to £40,000, or even more to reduce borrowings.
For other pensions savers with Protected Rights, we can expect to see more 'investment only' SIPPs set up, where a broad selection of funds, perhaps via a fund supermarket, gives a wider investment choice than the old pension plan used to hold Protected Rights.
As well as greatly helping individuals, independent financial advisers (IFAs) should be winners. Many IFAs are champing at the bit here, aware of the potential benefits for their clients. Pension advice can be a complex and technical subject, so this is a great chance for advisers to demonstrate their ability to add value. Advisers can contact clients at what could be an important time; the credit crunch has swept through the world's investment markets, so investment strategies within a pension fund may need reviewing anyway.
Who could lose?
If advisers and clients are winners, then insurance companies are potential losers. A large slice of Protected Rights funds are sitting in insurance companies and may not be in the best performing funds. For one thing, the lack of competition over Protected Rights failed to encourage insurers to produce outstanding results in order to retain funds under management. Now, insurance companies will have to ensure that their own offerings are attractive enough to retain some assets, which is as it should be.
The Government is another player that could be seen as both a winner and a loser. A winner because for many, the change is good news and the government will earn kudos for delivering it. At the same time, there are still questions to be asked and many wonder why it took so long to act and why some tidying up still needs to be done - for example, Protected Rights will have to be ring-fenced within a SIPP until 2012, therefore increasing the administration costs.
In addition, Protected Rights cash can be used for income drawdown both before age 75 and post-75 in an Alternatively Secured Pension (ASP). However, if individuals want to use a scheme pension to take an income they cannot use their Protected Rights funds. It is expected that this will change in 2012, when contracting out for defined benefit schemes ends, but for individuals assessing their retirement options now this is too late.
Another discrepancy in the current regulations is that Protected Rights cannot be held within a small self-administered scheme (SSAS). Despite the obituaries, SSAS remains a valid pension vehicle for small business owners and should also be able to hold Protected Rights. As a result of this anomaly, SSAS holders with Protected Rights face the extra cost of using a SIPP alongside their existing SSAS to make the most of self-investment, or converting their SSAS into a SIPP and losing facilities such as making loans back to the sponsoring employer and the ability to hold shares in the sponsoring employer.
Overall, we should give two, or even two and a half cheers, to the Government for moving on the Protected Rights issue. Most importantly, pension savers and their IFAs will be grateful, while insurance companies that cannot raise their game to compete may see fund outflows. This will be a good thing - money trapped in poorly performing funds should be liberated and redirected to where it can have the greatest long-term beneficial effects.
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