SIPPS: FREEDOM FOR OLD PENSIONS

Investors Chronicle, 1 October 2008

Do you have any old pension pots lying around that haven't seen much attention of late? Then some new legislation could help you breathe new life into them.

Pension investment possibilities are about to get a lot more interesting with the announcement that from 1 October 6m people with protected pension rights pension funds averaging £16,500 can at last move the money into a self-invested personal pension.

This is very exciting news for the Sipp providers, who are salivating at the prospect of receiving massive inflows - the total sum of protected rights money is estimated to be £100bn.

Whether it is a good idea for your own pension money is another question, to which the answer is probably yes, but not in all cases. And unless you're a pension nerd, you're probably asking "What are protected rights? And how do I find out if I have any?"

The short answer is that if you have ever opted out of the state second pension scheme then you probably do. It's highly likely that you're affected as at least six million people have contracted out of the state second pension, previously known as SERPS (State earning related pension scheme), since 1988. Many people will have done so through their occupational pensions schemes at work.

What are protected rights? And do I have them?

Protected rights is the term used to describe funds built up in a private pension scheme from rebates of National Insurance contributions paid to people who forego the retirement and death benefits that would arise from membership of the state second pension. Basically, you can contract out of the state second pension and receive payments (rebates) from the government paid into your private pension instead. You have given up a guaranteed state pension for money up front that you can invest yourself for your retirement.

To check if you are contracted out, call the HMRC Contracted Out Pension Helpline on 0845 9150150. Have your national insurance number handy. There is a government service which can help you track lost pensions or you can call the Pension Tracing Service on 0845 6002 537.

The government has always taken the view that protected rights are a part of the state pension. As such they should work in the same way as the state pension. They also insisted that no great risks should be taken with the monies in protected rights, which meant that protected rights were off limits for investment in Sipps. This means that protected rights were generally invested in insurance company managed pension funds, which managed the risk but did not lead to star investment performance.

However, when Sipps came under the regulation of the Financial Services Authority in 2007, the government became more open to the idea of allowing protected rights to be invested in Sipps.

Winds of change at the FSA

In June 2008, the Department for Work and Pensions finally confirmed that it would permit protected rights funds to be invested into Sipps from October and elated Sipp providers have been gearing up to receive an influx of new funds.

A handful of Sipp providers are already offering the option to combine protected and non-protected rights within a Sipp, having circumvented the rules through establishing a private managed fund linked to a personal pension policy. However, the new rules will bring more clarity.

Richard Ellis, head of sales and marketing at Merchant Investors says: "Self-investment of Protected Rights in Sipps is not something new; it has in fact been possible, through the right kind of Sipp, since personal pensions were first introduced in 1988.

"It does make sense to create a level playing field, but before everyone rushes off to invest their protected rights, study the devil in the detail.

"One of the most interesting short term effects this new legislation has is that protected rights held in Sipps will still need to be separately identified from other funds until further rule changes are made in 2012. For some providers this will not create a problem but for others having to identify protected rights and non protected rights will mean system upgrades. Ultimately this could mean some providers may not be ready by October 1st.

"So although this is great news for the investor, I would suggest a degree of caution. But it will be fascinating to see how the industry and fellow providers adapt and move on over the next few months in light of this change."

Although full investment control of protected rights money is possible from October, some restrictions on how benefits are taken remain in place until the government abolishes the state second pension (expected to be in 2012, but could be later).

Regulatory regime

Protected Rights will still be separately segmented and rules governing how the benefits from these schemes can be taken remain in place. In particular there remains a requirement that when purchasing an annuity it must include a pension for your spouse or civil partner at the rate of 50 per cent. Additionally this annuity has to be bought on a unisex basis, which means it is more beneficial for women than men because statistically, women live longer.

If you have built up a variety of pensions over your working life then the rule change will make it easier for you to consolidate and manage your pension investments within a single pension product.

Until now protected rights held in personal pensions have been invested with insurance companies. Unfortunately many insurance companies only offer pension investors a limited range of funds to choose from and many of them do not perform well. Killik & Co, the advisory stock broking firm, says some investors could now have a protected rights fund worth around £53,000. Such a decent sum as this should not be languishing in poorly performing funds.

Poorly performing funds can make a big difference in retirement. If the average protected rights pot of £16,500 is invested for 20 years in a fund returning 7 per cent a year, financial advisers and Sipp providers Hargreaves Lansdown says this would be worth £52,000. But if invested in a fund returning 5 per cent it would only be worth £36,000.

If you've not been happy with your pension fund or the limited range of investment choices available, then a Sipp may offer the opportunity to revitalise your pension. Although an ordinary personal pension may provide you with a fund that performs well, a Sipp will have a greater choice of funds, and greater scope for picking a good fund, plus a better selection of alternatives if your first choice does not meet expectations.

Malcolm Cuthbert, managing director of financial planning at Killik & Co says: "Allowing protected rights to be held within a Sipp is good news for those who wish to consolidate their pensions, gain access to wider investment choices and are comfortable with taking more of a risk in the hope of delivering greater returns.

"Before deciding what to do next, kick the tyres on your existing arrangements to check whether you are happy with the investment choices and returns achieved so far - particularly if monies are in closed life companies or in with-profit funds.

"Those fortunate enough to have generated rebates around the £50,000 mark by contracting out since 1988 may feel content to stick with the status quo. However, if your protected rights pot has fallen short of this figure whilst languishing in an underperforming life company fund, it may make sense to review the funds selected or consolidate all monies into a Sipp where greater investment choice - such as shares, investment trusts, exchange traded funds, warrants, fixed interest securities, and CFDs as well as commercial property - could generate greater returns."

Investment options:

The government will allow protected rights money to be invested in the full range of investment products permitted by the Sipp tax rules.

CASE STUDY: Tony Arkinstall

Mr Arkinstall, 49, an IT director from Henley-on-Thames, contracted out of the state second pension in 1991. He has built up approximately £50,000 in contracted-out benefits from this period.

He says: "When I contracted out I simply went into the default fund, because that's what you did back then. Having had a Sipp and looking at potential returns a little more critically I can now see that the performance of my protected rights fund has not been great. When you look at the projected income on retirement it does not look promising, so I am planning to move it into my Sipp. I can then start to be a bit more aggressive and invest for higher potential returns."

Mr Arkinstall took out a personal pension at the same time he contracted out. This pension carried high charges and with disappointing investment performance, therefore he has not transferred these benefits into his Sipp. Once he has consolidated everything under one roof, he will have considerable flexibility across both how he accesses his income and his investment options. By selecting a discretionary managed approach, he is hoping he can now have greater peace of mind when it comes to his pension.

(Case study provided by Killik & Co)

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