The Cutting Edge with John Lawson – Standard Life Pensions Ezine

Standard Life's Pensions newsletter for advisers

Issue 3: Jan 2007

The pace of pension reform seems to accelerate relentlessly. Is 2007 likely to be any different? Here are some predictions of what advisers need to be aware of over the next 12 months.

Pensions Bill
A Pensions Bill received its first reading before Christmas 2006. But virtually all the measures in it have no immediate impact on the pensions landscape. The changes include linking basic state pension (BSP) to earnings ‘sometime over the course of the next parliament’. Also, the number of qualifying years needed to get a full BSP will be reduced to 30, this change coming in 2010.

State second pension (S2P) changes are also part of this Bill. Eventually, S2P will become flat rate. In preparation for this change, the top accrual band (20%) is being scrapped. This means that there will only be two bands; 40% for earnings up to the lower earnings threshold (currently £12,500) and 10% above this threshold and up to the upper earnings limit. These changes will be made in 2010. An associated change – the removal of the right to contract out via a personal pension – will take place in 2012.

The one area where the Bill has immediate relevance is in establishing a delivery authority to advise government on setting up and managing personal accounts. This new body should be operational ‘by mid 2007’ and will start to advertise for its first recruits in spring.

Impact of personal accounts
There is potential for personal accounts to have a significant impact upon the pricing of group pension schemes in 2007, whether stakeholder, group personal pension or occupational. Work already undertaken by some large providers suggests that up to two-thirds of employers will close their schemes to new members in 2012 when personal accounts are introduced.

Based on my calculations, group money purchase schemes that pay initial commission typically take somewhere between 12 and 14 years to break even. However, if schemes set up in 2007 are likely to close to new members in 2012, the break even point would be pushed back significantly. In some cases, the scheme might never break even.

In response to this significant risk, the pricing of new schemes is likely to move to a front-end loaded structure. We have already seen a shift in some providers, including Standard Life, to this new basis. Other providers are now beginning to price schemes based upon administrative costs and when those costs arise; for example, establishment charges and annual per member charges.

Guaranteed minimum pension as a scheme benefit
For defined benefit schemes, the Pensions Bill will bring forward rules on allowing guaranteed minimum pension to be treated as a scheme benefit as long as the replacement benefit is ‘actuarially equivalent’ to the GMP it displaces. This could be harder to demonstrate than meets the eye.

Treatment of protected rights
One possible change that didn’t make it into the Pensions Bill was a change in the treatment of protected rights to bring them into line with voluntary savings. This is an important change for advisers as it would allow self-investment of protected rights. With £75 billion plus of protected rights funds out there (based on rebates into APPS being average £4bn per year since 1988), this is potentially a big consolidation opportunity, but we need to see legislation. It is still possible that this could be legislated for in 2007, but that is now looking increasingly unlikely.

A consultation in late summer 2006 suggested harmonising the rules for protected rights with those for voluntary pension saving. As well as allowing self-investment of protected rights, there would be no need to buy a spouse’s pension and annuity rates would be gender-specific rather than unisex. At that point, things looked pretty positive. The tone of the consultation was more ‘how do we do this’ rather than ‘whether we should do this’.

Spouse’s pensions
Unfortunately, the same old sticking point has come back to the fore; spouse’s pensions. And, more pertinently, politician’s concerns that feckless married males will buy single life pensions because that gives them a higher starting amount. The issue is included in a discussion paper issued alongside the 2006 pre-budget speech dealing with the post retirement market.

Make your views known
Although this paper is not really a consultation, I would always encourage advisers to make their views known (in this case to the Treasury). There is no substitute for anecdotal evidence from the coal face of the difficulty that these petty rules cause in helping people plan for retirement.

Calculating transfer values
Another defined benefit issue, dearer to the heart of many advisers than GMP, is the calculation of transfer values. Inadequate DB transfer values has meant that recommending transfer is virtually impossible, even considering the cash bungs frequently offered alongside. In truth, there should be no need for inducements; transfer values should fairly represent the benefit surrendered. Hopefully, the new statutory transfer value calculation basis, consulted on in 2006 and promised for April 2007, will give leavers fair value in return for giving up deferred benefits.

Still to come....
As 2007 draws to a close, yet another Pensions Bill is expected. This time it will introduce the enabling legislation for personal accounts. It will also convert the ‘advisory’ delivery authority into an ‘executive’ delivery authority with the power to negotiate contracts, appoint suppliers and so on.

It seems that in 2007 at least, the relentless pace of reform will continue. Watch this space for updates on these issues and new ones picked up on the radar screens.

Tax and legislation are liable to change. This information is based on Standard Life's current understanding of law and HM Revenue & Custom's practice. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments. Standard Life accepts no responsibility for the information contained in the external websites referred to. These are provided for general information only.