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Adviser  >  Technical Central  >  Information & guidance  >  Investment  >  Investment of protected rights funds

Investment of protected rights funds

Background

Part of the State pension which employed people can receive is related to their earnings. The two main earnings related State pensions are the State Earnings Related Pension Scheme (SERPS) and State Second Pension (S2P) which superseded it from 6 April 2002. Details of S2P can be found at The State Second Pension Explained. 

It is possible to ‘contract-out’ of these schemes via occupational schemes or personal pensions (including stakeholder pensions). Someone who contracts out via a defined contribution occupational scheme or personal pension plan continues to pay the higher contracted in national insurance contribution but the pension scheme receives an age related rebate of national insurance contributions from the Department for Work and Pensions. A personal pension used to contract-out is called an Appropriate Personal Pension (or APP). 

The part of the fund that is provided by the rebate is called ‘protected rights’. The protected rights are taking the place of the State Second Pension and/or State Earnings Related Pension Scheme the member would have received from the State had they remained contracted in.

As protected rights are meant to replace the State benefits foregone by contracting out, the government has until now taken the view that these funds should not be over exposed to investment risk. Protected rights funds are therefore currently restricted to investing in insured funds, interest bearing accounts or collective investments such as OEICS.

Although a few insurance-based Self-Invested Personal Pensions (SIPPs) can comply with these restrictions, the majority can’t and so they can’t accept protected rights, or at least not directly. However, APPs can have a SIPP attached (though not vice versa) and so protected rights can be paid into the APP part while the SIPP is used for self-investment.

Another major reason for not allowing SIPPs to hold protected rights was that until April 2007, the way SIPPs were marketed and sold was subject to low levels of regulation.

What’s happening?

In April 2007 the FSA implemented a new regulatory regime that meant that the marketing and selling of SIPPs became fully regulated for the first time. As a result of this, the government decided that the current rules on protected rights in SIPPs are too restrictive.

Therefore in December 2007 the DWP issued a consultation document proposing to allow SIPPs to hold protected rights rather than having to hold protected rights in a separate plan. The response to the consultation was produced in June 2008. The Personal and Occupational Pension Schemes (Amendment) Regulations 2008 were then laid before Parliament on 29 July 2008. These Regulations confirm that the change will take place in October 2008. As a result, from that date protected rights in SIPPs will be able to be invested in the full range of investments available to other funds in SIPPs, including commercial property.

In the consultation document, the DWP also noted that the Pensions Act 2007 provided for the abolition of contracting out on a defined contribution basis with an expected implementation date of April 2012. The response document stated that from that date protected rights will no longer have to be tracked separately and that individuals will be able to choose the pension or annuity that best suits their circumstances. This means that from April 2012 it will no longer be a requirement for protected rights to provide survivor’s benefits.

However tracking of protected rights may still be advisable as in some cases protected rights would need to be converted to GMP if transferred to a contracted-out defined benefit scheme.

Until April 2012, although it will be possible to hold protected rights within a SIPP from October 2008, it will still be necessary for protected rights to be tracked separately and for them to provide survivors pensions. Other requirements such as annuities from protected rights to be provided using unisex rates will also still apply until April 2012.

The response document also proposes to make a minor changes to contracting out legislation to remove the provision that permits a survivor's annuity to continue to be paid to any other person if the survivor dies during a five-year guarantee period. This change is being made to bring DWP legislation into line with tax law that prevents a dependants annuity being guaranteed for a minimum number of years, or being paid to someone other than a dependant.

Any research and analysis has been provided by us for our own purposes and the results of it are being made available only incidentally.

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.

Published 21 July 2008

Updated 12 August 2008