Changes affecting contracting out...

Milarky

Adrian Boulding - Pensions Strategy Director at Legal & General:

According to this gentleman on BBC's Moneybox programme this morning, the contracted-out rebate will, after 2006, be just like the rest of your pension fund and can be partially commuted to a 25% lump and whatever pension the rest will buy.. He also said that the new ‘higher’ minimum age of 55 for taking personal pension benefits will then form a common age for both protected rights and non-protected rights bits - so that the benefits of contracting out can also be taken from 55 [rather than age 60, as at present]. (Unless he’s cocked up it’s got to be accurate.)

Here’s what was actually said..

[Paul] Lewis: Are there any practical differences between the benefits you’ll get from the state and the benefits you’ll get from a personal pension?

Boulding: The two benefits are of equivalent value but the personal pension plan is more flexible in the form that you take it in… You can retire from a personal pension at age 60 at the moment. After the Pensions Bill, which is going through Parliament, you’ll be able to retire from age 55 - whereas with a state pension you have to wait until 65 (..60 for a woman, which in due course is also going to rise to 65) Also 25 percent of the pension could be taken as a tax-free cash sum under a personal pension plan once the current Pensions Bill has made its way through Parliament. There is no tax free cash available from the state pension.

dunstonh

There has been some rumours that the contracted out segment could allow a tax free lump sum in the future but i havent seen anything yet. Currently only pre royal assent july 1989 personal pensions can get a tax free lump sum from contracting out (btw, you wanted a case where contracting out is the right thing to do, pre royal assent pensions would be one of them).

I think this chap has made an error or has let something slip. If true, it would be good news for IFAs

Milarky

Yes, if it was accurate then that also has the effect of  'revaluing' any protected rights [for years 1989-2005] otherwise built up - since a tax free lump sum paid out can itself be used to attract a bit of further tax relief via added contributions which then gets a smaller 'tax-free' lump, so that can then be used to do the same thing... and so on!

It works out at exactly '117/106ths'  [about 10% more in other words] for a basic taxpayer. (Can't be bothered to sit down and work out the equivalent factor for a higher rate taxpayer now - but someone will, or has, no doubt!)

We'll have to see if this gets shot down or corrected at some stage?

Pal

It is still unlikely to be worth contracting out though.

robnye

It is still unlikely to be worth contracting out though.

i have been contracted out for years. last year i got a pension forcast which agreed, as my serps contributions was 0

would your statement above still apply

nb i am in my late 30's

Pal

i have been contracted out for years. last year i got a pension forcast which agreed, as my serps contributions was 0

I don't understand what you mean. Your pension forcast agreed with what?

robnye

sorry, i didnt word it properly.

I requested a pension forcast earlier this year, on the forcast it stated that my serps fund had 0 (Zero) contributions, due to having contracted out from when i started work.

in which case, if my serps pot is empty now (after 21 years working), is it worth me contracting back in?

Milarky

On precautionary grounds it is certainly worth contracting back in. Remember that you will be getting 'something for something' namely an entitlement to a 'slice' of income for each year you remain 'in' the state second pension [S2P] and this 'slice' gets revalued in line with average earnings [rather than just prices] for each year until retirement. The following year you get another 'slice' and so on...

What you get as 'contracted out' person of course is the rebate - and if the remarks attributed to the man from L&G above are borne out this would [for the first time] include the option of a 25% lump sum rather than all of the rebates having to be used to buy an income.

The 'income' you can buy with a given rebate depends on i) how much growth your rebate achieves and ii) how long you wait to retire and iii) what annuity rate is available in the future. In other words the 'equation' comparing what you will get under 'contracting-in' and what you might get under contracting out is very foggy indeed.

No one is really anymore saying ''contract out to get a better level of income'' because you would have to do quite well even to get the same level of income as things now appear. But the contracting out option does allow you to take the benefits somewhat differently if you wish. [eg retire before state pension age - possibly take some cash instead - possibly get a better rate if without dependents at the time - possibly go for a 'level' anniuty rather than an indexed one]

If thinking of contracting in I would at least find out the cut off date for doing so [It is likely to be some time after next April for the current tax year]

robnye

is there a simple (i know this is pensions we are talking about).... ???

is there an easy way to estimate whether 25 years of contracting back in would be financially better than another 25 years contracting out?

dunstonh

is there a simple (i know this is pensions we are talking about).... ???

is there an easy way to estimate whether 25 years of contracting back in would be financially better than another 25 years contracting out?

Yes, your details can be input into an illustration from a provider and they will show the DSS benefits lost against the protected rights pension benefits gained. Whichever is the higher is the one you go for.

Milarky

Yes, your details can be input into an illustration from a provider and they will show the DSS benefits lost against the protected rights pension benefits gained.   Whichever is the higher is the one you go for.

DD,

How 'valid' is the modelling used? For instance I can think of the following

1) Percentage rate of rebate changes each year - it is age-related
2) Thresholds for calculating rebate change each year [assume that is RPI indexed?]
3) Thereafter the 'defined' benefit given up revalues in line with a different index [National average earnings]
4) Rebate can [and is!] paid at random times of year.

Obviously several assumptions have to be made - it is just comparing two sets of hypothetical future earnings invested in different ways.

Does the advisor's model not generate a ''required rate of return'', rather than a ''what you might get'' type-answer, since knowing by how much the same rebate is effectively returning within the state system is something it would be truely useful to know?