Useful Changes to Contracting Out Rules

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.

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