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