Guest article, written by Chris Wicks.

The government has just introduced new rules which will improve the choices available to millions of pension policy owners. The rule changes, which will come into effect on 1st October 2008, affect those with Protected Rights Benefits. These are acquired when an employee person opts out (known as Contracting Out) of the State Second Pension S2P (previously known as the State Earnings Related Pension Scheme- SERPS).

Protected Rights can be acquired in a number ways:
1. Via a Personal Pension or a Stakeholder pension. Employees pay the full rate of National Insurance Contributions. After the end of each tax year the Revenue work out how much has been paid and rebate a part of this into the employee’s plan (something I am frequently asked about and the subject of a later blog).
2. Via Contracted Out Money Purchase Schemes (known as COMPs). These are employer sponsored pension schemes. The employees pay reduced National Insurance Contributions and the employer makes minimum contributions to the scheme.
3. Via Final Salary Pension Schemes (also known as Defined Benefit Schemes). These are schemes that provide a promised level of benefits to members when they retire, typically based on their final earnings and years of service. Where the scheme has opted out of S2P, these are expressed in the form of a pension but they can be expressed as Protected Rights or converted especially if the benefits have been transferred.
4. On divorce or termination of a Civil Partnership where a Pension Sharing Order is made. In such circumstances the pension benefits of one of the spouses/civil partners is allocated under a Court Order to the other. The benefits can be provided within the same scheme but more typically the scheme will require that they be transferred out.

Successive governments have imposed restrictions on the way in which Protected Rights may be paid out. Quite a few rules have been removed in the last few years and the remainder should disappear all together from 2012. However, for now, benefits must be taken from age 50 (55 after 5th April 2010) and these must include a spouses/dependents benefit. It is also currently a requirement that they only be invested in insured pension arrangements.

On 1st October 2008 the new rules will allow Protected Rights Benefits to be transferred into a Self Invested Personal Pension (SIPP). Until recently these types of schemes were not regulated and as a consequence transfers of Protected Rights into them were prohibited. SIPPs allow investment in a wide range of assets including stocks and shares, investment funds and commercial property. It is also possible to borrow 50% of the value of the assets in the fund to assist with the purchase of new investments, such as buildings.

The ability to invest in commercial buildings is particularly useful to business owners wanting to invest in new premises. SIPPS can even be used to buy the premises already owned by the business, thereby releasing the capital locked up in the building. The proceeds received by the business can be used to help finance expansion, or even to simply pay off accumulated debts.

If the SIPP buys trading premises for the business, the business is required to pay a market rent which is fully relievable against its taxable profits but received tax free by the scheme. As the scheme does not have to pay tax on its rental income all of it can be used to reduce its borrowings. This results in the earlier repayment of the borrowing which means less interest will be paid.

A group of SIPPS owned by different individuals can collectively purchase premises. This is a method used by quite a few professional firms such as lawyers and accountants as well as doctors and dentists.

This is not just an opportunity for new investments but also for top-ups to existing schemes. These can be used to make additional investments. Alternatively the additional funds can be used to reduce scheme borrowings.

As with any transfer of benefits it is important that professional advice is taken from an appropriately qualified independent financial adviser. They will be able to review all of your options for you as well as make sure that you are fully aware of any adverse consequences of transferring your benefits.

Chris Wicks is a Certified Financial Planner and Director of N-Trust Limited.

He blogs on his specialist subject of pensions and retirement income at http://chriswickscfpretirementspecialist.blogspot.com

Steve Bee wrote here recently about the Pensions disaster around the corner (Originally on Citiwire.co.uk) contrasting the poverty of private pension schemes compared with largesse paid out to pensioners in the state sector.

His article provoked a huge debate on the Money Blog about public sector pensions, with taxpayer outrage on one side and spirited defence on the other, usually on the grounds that lower-paid public sector workers deserved such benefits.  

Steve highlighted the changing shape of pension provision in the UK that may be all too familiar to you - namely that whereas in the past final salary pension provision was the norm for all large and many smaller employers, that is no longer the case.

Now,  he says, there are fewer than half a million employees in the private sector in open pension schemes of this type against 5 million public sector employees.

Why the difference?

The glib reason is always cost. Pensions are getting more expensive. We are on average living longer, meaning we receive our pensions for longer. However there has been the double whammy of lower investment returns, meaning that our savings during our working life time grow less, and the annuity cost of our pensions is more.

A decent index-linked pension at normal retirement age now costs around £25 for each £1 of annual pension. So if you want to retire on an income of £25,000 you will need a pension pot of £625,000.

For the private sector, the rising cost of such pension promises is a big problem. However it would be manageable except for two compounding issues: value and risk.

Value first. Despite the recent strike over pension scheme changes at the Grangemouth oil refinery, it is generally true that employees do not place the same value on £1 in their salary compared with £1 in their pension scheme. The employer gets less ‘bang for his buck’ funding his pension scheme.

The second issue is the risk that a final salary pension scheme puts on an employer. Since new legislation in 2003,  a company has to make good the funding of all those promises, whatever health improvements or investment conditions throw at it. Many finance directors think that they already have enough risks in their business.

So how can the state buck the trend by continuing to offer such gold plated pension schemes?

First off, because it – or rather you and me as taxpayers - can take almost unlimited risk. And the decision makers at the top really do value their final salary benefits because they will be amongst the biggest beneficiaries.

So it comes back to cost. And here the state has a huge advantage. Most public sector pension schemes are unfunded, with the Government paying out pensions from income rather than putting money aside from employer and employee contributions as happens (or did happen) in the private sector.

It does at least calculate the size of the promises its building up in the national accounts. Currently it shows that cost to be about £700 billion.

That is a huge number by anybody’s standards. However most observers believe that even that staggering figure is too low.

How do we know that? Oddly enough, we get a glimpse of the true figure when married couples split up.

At Bradshaw Dixon Moore we value pensions on divorce, including those of public sector employees. We value them on a consistent basis and time in, time out, we produce results much higher than the state-provided valuations.

For example we recently valued a local authority worker’s pension at £140,000 instead of the government’s assessment of £84,000. In another case involving a pension in payment, the lump sum was valued at £608,000 instead of £380,000.

Uniformed services are especially tricky. A police case with a government valuation of £114,000 we valued at £181,000 assuming they left the force immediately. Allowing for their generous early retirement terms, we worked it out at a whopping £360,000.

No wonder some observers such as the Institute of Economic Affairs puts the true cost of the public sector scheme pension debt at more than £1 trillion, or £1,000 billion if that’s an easier figure to understand.

Remember, one way or another, taxpayers are funding this burden. Can the state really afford to buck the trend forever?

Nigel Bradshaw is chairman and actuary at Bradshaw Dixon Moore

The recent strike by workers at the Grangemouth refinery that put the nation’s oil supply on the line was brought about because of threatened changes to the workers’ pension scheme. People are getting hot under the collar about final salary pension schemes closing to new entrants at last, but I fear it’s too late. Far too late in fact.

Final salary pension schemes are referred to quite nostalgically these days as the ‘gold standard’ of pensions. They were all the rage in the 1960s and 1970s and the funds held in them grew to titanic proportions in the heady days of the 1980s and 1990s.

 
Those titanic funds hit the iceberg of reality at the turn of this new century and for the last few years boards of directors up and down the land have been manning the pension lifeboats now that the Government has stopped them jumping ship. It’s not been possible since 2003 for solvent companies to walk away from their pension liabilities. These days companies have to buy their way out.

The first step most private sector companies with final salary pension schemes have taken is to close them off to new entrants. Around 80% of our private sector pension schemes are now closed to new entrants. According to the Association of Consulting Actuaries (the ACA) only around 900,000 private sector employees are currently in final salary schemes that are open to new employees.

At the moment that number still includes the employees working in the Grangemouth refinery, but it won’t if the changes proposed there go ahead. Bit by bit, up and down the land, our private sector final salary schemes are having the lights turned off.

Closing schemes to new employees is a bit like cutting the roots off a plant. Without the new entrants coming into the scheme it will eventually wither on the vine. As more and more people leave the closed schemes through retiring or changing jobs, say, and are not replaced then the number of private sector employees accruing final salary pension rights will be reducing all the time. Every day fewer and fewer people working in the private sector are building up salary-related pension rights. One day nobody will be.

In stark contrast to what’s happening in the private sector in the UK our public sector final salary schemes are as strong as ever. Today around 5 million employees in the public sector are in final salary schemes that are still open to new employees.

Those figures, of less than a million employees in the private sector against around 5 million in the public sector, tell you all you really need to know about what the pensions landscape is likely to look like in the UK in a few years time.

Our private sector final salary schemes will have been almost completely replaced with cheaper and, for employees, riskier money-purchase schemes, whereas public sector employees look likely to hold on to their gold standard pensions.

But at what cost to the public purse? There’ll be loads written about this one day when it’s so obvious that even Joe and Josephine Average can see what’s going on. Mark my words.

Steve Bee is head of pensions strategy at Royal London Group where he publishes his BeeHive blog at www.scottishlife.co.uk/beehive

Steve bee writes every week for citywire at http://www.citywire.co.uk/personal/-/personality-finance/Making-the-most-of-it/list.aspx

As you may expect, our clients regularly ask us all sorts of questions about pensions and their valuation in divorce. Those about pensions and actuarial matters are easy enough, but life becomes much more difficult when lawyers query the legal basis for the use of one valuation rather than another.

We have a natural aversion to upsetting clients; which is why we do not attempt to tell anyone anything about divorce law. It is much better when we find someone to do the job for us! That is why we were so pleased to discover an excellent paper written by Mr John Buck, a member of the Family Law Bar Association. John is a barrister at Tanfield Chambers and he wrote his paper to accompany a “Pensions in Ancillary Relief” seminar last year. Even without the benefit of the seminar, we believe that the paper can help when wrestling with the challenges of dealing with pensions in divorce. For example:

“ … Bennett J rejected a submission on behalf of H that the value of his pension fund (which had not vested) should be the CETV less the 25% which can be withdrawn as a lump sum …”

In just nine pages, Mr Buck has succeeded in dealing with many of the issues that we regularly encounter. We are grateful to him for giving us permission to make his paper available here. The views expressed are of course those of the author and not necessarily those of our firm. Please click here to access and download the paper in pdf.

If you do not have a pdf reader installed on your computer, Adobe™ one of the world leaders in this technology, provide free downloads from their website.

Peter J Moore – Director, Bradshaw, Dixon & Moore Ltd.

© Bradshaw Dixon & Moore Ltd – March 2008

Henry Frankenstein : Look! It's moving. It's alive. It's alive... It's alive, it's moving, it's alive, it's alive, it's alive, it's alive, IT'S ALIVE!
Victor Moritz : Henry - In the name of God!
Henry Frankenstein : Oh, in the name of God! Now I know what it feels like to be God!

Frankenstein (1931) Director: James Whale

 
It sometimes seems that with each visit a wealthy divorcing family makes to the House of Lords a new concept is crudely sewn on to the 35 year old divorce law like an extra limb. There was ‘reasonable requirements’ in the 1970’s. ‘Equality’ in 2000. Now after the House of Lords has brutally tortured the wording of the 1973 Act like never before, there is ‘compensation.’ None of this is in the statute. The net result of all this industry is to make the law into an unpredictable lumbering Frankenstein’s monster that roams the land striking terror and confusion into the chambers of District Judges and driving up costs.

This sort of judicial ‘creativity’ can make it harder to advise divorcing parties because none of us know when a limb will fall off the monster or where a new incompatible body part might bolted on. Surely the law needs to be either applied as it is written, or better still it needs to be re-enacted taking into account such concepts as pre-nuptial contracts, equality and the concepts of matrimonial and non matrimonial property.

These days the courts will distinguish between matrimonial property and non matrimonial property. This means that assets built up within the duration of the marriage will be shared, but assets earned or acquired either before or after the period of co-habitation may not be.

Given the emphasis in recent case law Miller [2006] UKHL24 and Rossi [2006] EWCH 1482 – on sharing the ‘matrimonial acquest’ there seems to be no reason why the same principles should not be applied to pensions built up prior to the marriage, or post separation. Many actuaries are instructed in the case of a long marriage to say how a pension might be divided up to provide an equal income in retirement.

I have not yet seen an instruction to an actuary that aims to apply a distinction between matrimonial pension and non matrimonial pension but some readers might have done. In an appropriate case such an approach would be justified. Suppose a husband gained an inheritance 18 months after separation and put in into his existing pension fund. As long as the wife’s needs could be met with a fair share the matrimonial assets there might be no good reason why the husband should not retain the inheritance in the form of the increased pension. It would need to be carved out of the pension fund of course but that is what you use an actuary for.

But what will the wife say if confronted by the husband’s argument of post separation property ring fenced for his own use. She might draw on the ‘extra statutory’ Miller concept of compensation. She could say that but for this divorce she too would be enjoying the fruits of the husband’s inheritance in the form of extra pension.

And to bolster her compensation argument, could she not ask the court to blow the cobwebs and dust off MCA 1973 S:25(2)(h). This subsection is routinely ignored but is clearly still a part of the law. Its purpose is to ensure that the court takes account

‘…..of the value to each of the parties to the marriage of any benefit (for example a pension) which by reason of the dissolution or annulment of the marriage, that party will lose the chance of acquiring’

How long I wonder, will it be before the courts are confronted with the eerie spectacle of S:25(2)(h) as it rises smoking from it’s creaking coffin like a resurrected vampire, woken by the taste of blood on it’s lips that dripped from the alien concept of ‘Miller Compensation’.

Tom Tyler is a family law barrister at 4 Brick Court chambers