First introduced back in April 1988 as the benefit format for contracting-out of the State Second Pension via money purchase pension arrangements, Protected Rights will bow out in April this year when this contracting-out option is finally abolished.
With effect from 6 April 2012, Protected Rights will cease to exist as a separate entity, and simply become ‘Ordinary Rights’.
Those still contracted-out will automatically be brought back into the additional State Pension, and dependent on earnings, may then begin to accrue entitlement to this state benefit from this date. Those still contracted out via a money purchase occupational pension scheme will see an increase in their National Insurance (NI) contributions, but only up to the standard rate payable. Currently, membership of such schemes grants entitlement to pay lower NI payments to reflect the fact that the difference is paid into the pension (referred to as the ‘rebate’ or ‘minimum payment’)
The end of Protected Rights will remove the burdens associated with having to secure spouses’* benefits on retirement and death, for clients either married or in a civil partnership. Its demise will therefore bring with it opportunities in the following guises:
- Annuity options
- Death benefit nomination
- Pension consolidation
- Proportionality rules
- Flexible drawdown
Annuity options:
The key change here is the removal of the mandatory 50% spouse’s* benefit on annuity purchase. Not only is the spouse’s* pension compulsory, but the rate is fixed at 50%, whereas ordinarily up to 100% can be chosen.
Protected Rights are also subject to unisex annuity rates, whereas rates used for Ordinary Rights are gender specific meaning rates are currently higher than for women because mortality rates are higher for men. Whilst gender-sensitive pricing is to be outlawed on 21 December this year, there is a short window for male annuitants to potentially access higher payments.
For those prepared to annuitise this year, even with current rates as unappealing as they are, at least the changes ahead will offer greater choice in terms of the bases available.
Death benefit nomination:
Unlike most pension lump sum death benefits, those payable from Protected Rights will often be liable to inheritance tax (IHT). This is because the current rules only allow a lump sum to be paid if there is no surviving spouse*. Any death benefit nomination made in respect of Protected Rights is therefore classed as an ‘irrevocable direction’, i.e. the nomination cannot be changed once made.
Once Protected Rights become Ordinary Rights, whilst any nomination already made will remain valid, it can still be changed. Post April 2012 could therefore be the ideal time to review Wills and/or death benefit nominations, with the new uncapped options in mind.
Pension consolidation:
Legislatively speaking, self invested personal pensions (SIPPs) have been allowed to accept Protected Rights since October 2008, when the rules on investment options for such rights were relaxed. However, that is not to say that all existing and available SIPP products have amended their rules to reflect this change. Legacy systems have also prevented some SIPPs from accepting such rights, whilst others have chosen to limit acceptance to separate policies which come with their own set of charges and terms.
However, the relaxations only allowed for SIPPs to accept Protected Rights going forward and not their occupational equivalent, small self administered schemes (SSASs). Therefore, once the differential between such rights is removed, all SIPP and SSAS clients can consider the viability of consolidating such rights within the scheme.
Proportionality rules:
Because of the requirement for Protected Rights to provide for a spouse* on death or annuity purchase, legislation dictates that where Protected Rights and Ordinary Rights are held within the same pension scheme the Protected Rights cannot be depleted at a greater rate. This is known as the ‘proportionality’ rule.
This rule has been a bone of contention for those keen to consolidate their drawdown pensions for ease, only to be faced with the mandatory requirement to take further benefits. However, whilst this rule will shortly disappear, drawdown pension transfers still require careful review to ensure there is no adverse effect on the maximum income available.
Flexible drawdown:
Incorporated in the pension rule changes effected in April 2011, the flexible drawdown option (the option for unlimited withdrawals) is not currently available for Protected Rights funds. For those with Protected Rights funds who qualify for flexible drawdown, 6 April 2012 simply brings about a greater capacity for uncapped withdrawals.
Still contracted out?
For those still contracted-out under a money purchase arrangement, the last rebate (in respect of this tax year) will not be payable until around July 2012. Therefore, any decision to take benefits or consolidate pension benefits once the Protected Rights distinction has disappeared may need to be further deferred to take into account the final rebate expected.
Ultimately, it should not be taken for granted that the cessation of Protected Rights will bring about an immediate change. Pension scheme providers or administrators may choose not to, or simply not be able to adjust to these imminent changes at all, or as quickly as required. However, this in turn can stimulate the need for a pension review.
It should also be remembered that for many, the ability to accrue Protected Rights has been a beneficial alternative to the promise of an additional pension payable from a State Pension Age that may rise further in the future.
* in respect of this briefing, spouse includes husband, wife or civil partner.