From October, a near-monopoly on these pensions will end, giving six million people greater control over their retirement.
Pensions. Yawn, dull, what a bore, right? Wrong, because I have some really welcome news which will benefit over six million people! I'll start by getting the technical stuff out of the way, and then explain why this is such good news for workers.
S2P and `protected rights' pensions
As well as your basic state pension, there is another state pension which you accrue during your working life: the State Second Pension, or S2P. Prior to April, 2002, S2P was known as the State Earnings-Related Pension Scheme (SERPS), which was introduced in 1978. How much extra pension you receive from S2P and SERPS depends on your earnings during your working life and your National Insurance contributions (NICs).
However, some workers have chosen to `contract out' of S2P and/or SERPS by opting out of these schemes. In return, they receive an NIC refund which can be paid into their company scheme or a special type of personal pension. The problem with contacted-out rebates is that these payments, plus their investment returns, must be kept inside what's known as a `protected rights' pension. (However, the Department for Work and Pensions (DWP) intends to abolish contracting-out from April 2012.)
Protected rights: a £100-billion rip-off
If your contracted-out rebates have not been paid into your company pension scheme, then they will be held inside a protected-rights plan. In fact, of the total of £440 billion invested in UK personal pensions, almost a quarter (23%) -- £100 billion -- is tied up in protected-rights plans. With six million holders, this means that the average protected-rights pension is worth around £16,500.
The big problem with protected-rights pensions is that they have performed very poorly when compared with new-style pension plans and other mainstream investment vehicles. Here's how the average pension fund has underperformed the average for unit trusts and OEICs (two popular types of investment fund):
No. of years | UT/OEIC outperformance versus pension fund (%) |
|---|---|
Five | 12 |
Ten | 22 |
Fifteen | 69 |
Source: Lipper, total return to 01/02/08
As you can see, over the past fifteen years, the average unit trust/OEIC has grown almost seven-tenths (69%) more than the average pension fund. Indeed, thanks to their poor investment returns and high charges, private pensions have failed millions of workers. The insurance companies running them have a lot to answer for!
From October: greater choice, control and freedom
So, most protected-rights pensions have been pretty awful. However, investors can do nothing about this, because they cannot transfer these funds into one of the new generation of low-cost pensions. For example, protected-rights funds cannot be transferred into a cheap DIY pension known as a SIPP (Self-invested Personal Pension).
Now for the good news [drum roll]: from October, the rule preventing protected-rights funds from being invested in SIPPs will be scrapped. Although this is potentially catastrophic news for insurance companies, it is great news for workers, who will finally be able to take full control of their contracted-out pensions.
Personally, I'm delighted at this news. Although this obscure rule change may not seem like big news, it means that, later this year, I can finally take control of money I have sitting in a poorly performing protected-rights pension plan. Despite being invested in the stock market for seventeen years, this fund has grown by under 6% a year, which is a terrible result.
Hence, as soon as October arrives, I will transfer this under-performing pension into my ultra-low-cost Vantage SIPP from Hargreaves Lansdown. I will then be able to choose exactly where to invest my money, aiming to improve on its poor investment returns to date. At last, I can have all of my personal pensions in one place, and under my complete control. Hurray!
In summary, if your protected-rights pot is invested in a poorly performing insurance fund, then consider switching it to a SIPP. This will allow you to choose from thousands of different funds and other investments and, at the same time, reduce your ongoing charges.
For example, a fund worth £16,500 growing at 5% a year would be worth £36,000 after twenty years. However, a yearly return of 7% would boost your pot to £52,000. So, in this example, switching to a better-performing fund making 2% a year more produces an extra £16,000 after two decades. That's a lot of money for an hour's work!
Many thanks to Tom McPhail of Hargreaves Lansdown for his help with this article.
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