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There is a huge amount of confusion regarding the subject of whether to have funds transferred out of the state top up pension scheme or not. Increasingly, financial advisers and product providers are unwilling or unable to advise on the subject, fearful of litigation in a world where the benefit of hindsight is used as a cast iron tool for the prosecution in all things financial. It is vital that contractors ensure that they are aware of all the issues surrounding the subject and consider the options now because every year of delay could be accentuating a problem that could have a significant impact on your retirement plans.
The Wilson administration of the 1970s realised that, due to changing demographics and increasing expectations of retirement, the basic state pension was falling woefully short of the needs of a modern economy. The State Earnings Related Pension (commonly known as SERPs) was introduced to provide an additional income in retirement, based on deductions made via the National Insurance (NI) system from wages throughout a working life. In this way earnings between a set band where taxed with the proceeds going towards provision of a top up state pension.
Unfortunately the figures used by the government did not stack up and so by the latter years of the Thatcher administration it was clear that there was a growing funding gap. Instead of remaining in a state sponsored top up pension, taxpayers were encouraged to 'contract out' and have funds applied to private pension vehicles instead. There was a blaze of publicity and the taxman sweetened these transfers by way of relatively generous rebates made from the National Insurance fund.
The Major years saw a further reduction in the benefits that could realistically be drawn from SERPS and continued to offer rebates for private provision. In 2002 SERPS was replaced by the Labour government and the State Second Pension (known as S2P) came into being and rebates for contracting out were slashed.
Many Contractors will have their pension affairs on auto pilot having filled in forms to contract out of SERPS/S2P many years previously. Others will wonder what all the fuss is about having remained blissfully ignorant of the issues and always within the state scheme. It is important that we make a conscious effort to think through this complex subject and at least make a judgment and live with the consequences however, rather than simply sleep walk towards retirement.
Most private pension providers have looked at the fact that the government has changed the level of rebate to contract out of the SERPS/SSP and have noted that these have been reduced from their original rate. The insurance company actuaries have also revised downwards the projected growth rates that they use to determine what can be gained on your investment in terms of stock market performance (performance which could in theory have meant that the income from an investment backed pension could have been greater than the state scheme).
These two factors have meant that nearly all the providers are now recommending that contracting back in makes most sense (the Prudential alone has written to 440,000 investors recommending just that). The insurance companies, banks and investment houses are taking an understandably hard nosed business decision on this issue, mindful of the fact that we live in a litigation prone world and that they do not want to be sued in later years for any shortfall that materialises-to encourage investors to contract back in is a relatively risk free route for them to take as the liability then falls back on the government who no-one is ever likely to successfully sue!
So if you a Freelancer looks at the subject in terms of pure mathematics then we would all definitely be right to rejoin the state scheme, however, there may be broader issues to consider which may well mean that you decide to remain contracted out or to contract out for the first time.
Investors could take the view that it is better to have greater control over your future within a private pension account and leave less in the hands of the politicians who will always be able to exercise greater influence over funds held within a state scheme.
Investors could also consider the fact that, thanks to the Pension Simplification of April 2006 a private pension vehicle will allow you to have far greater freedom as to how and when to take benefits-i.e. you will be able to take 25% of this fund as tax free cash on retirement which the state scheme will not allow and will be able to take benefits as early as age 55 whereas the state scheme will still be 65. Pension investors could also take a more optimistic view of future investment returns than the conservative insurance company actuaries have taken, which again will influence which route will ultimately have been the most sensible for you.
As a general housekeeping point, it is vitally important that funds already outside of the state scheme are now made to work as effectively as possible for Freelancers.
Many pension providers who were very actively marketing schemes to potential investors in the late 80s and 90s are now no longer open to new business thanks to the massive consolidation within the pensions field whilst other companies have simply decided to pull out of an increasingly low margin market. This has left thousands of investors languishing within poor performing funds run by managers who have little incentive in terms of having to market competitive performance figures to attract new business.
Many of these old legacy pension schemes still maintain the high charges that are thankfully a thing of the past for new investors who now enjoy competitively priced stakeholder style pension contracts with no initial set up costs and low annual costs. It is imperative that Contractors who have existing contracted out funds properly assess the commitment of their current provider and examine the charges that are inherent in the schemes to ensure that they gain maximum benefit from any potential growth. It is only by doing this that there is a realistic opportunity to exceed the state scheme benefits and properly enhance retirement prospects.
With so many variables to consider it could end up being a basic question of weighing up our trust in governments against optimism for investment performance but at the end of the day we will only know which route will have been best AFTER the event. At least by addressing the issues now Freelancers will have been in control of their own destiny rather than allow inertia to dictate the outcome.
For further information, and to discuss your personal circumstances please complete our Pension Finder.
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