Originally, it was only possible for final salary occupational pension schemes to contract out of the earnings related elements, for example via the NHS pension scheme, in which case the rights given up were more than adequately compensated for by the high quality final salary pension on offer.

‘Contracting Out’

It has been possible since 1988 to also ‘contract out’ of these schemes via money purchase occupational or personal pension plans whereby you continue to pay the higher ‘contracted in’ National Insurance rate but the pension scheme receives a rebate from the Department of Work and Pensions.

Protected Rights

The part of the pension fund which accrues as a result of the rebate is called ‘protected rights’ and broadly corresponds to the SERPS or S2P benefits the member would have received had they remained contracted in but is now a monetary amount in an investment fund rather than a guaranteed pension.

Where protected rights were transferred from a personal or occupational pension plan as part of a divorce settlement they became ‘safeguarded rights’ which unlike protected rights were not accessible before age 60 and it was not possible to take a tax free lump sum. However, with effect from 6 April 2009, these restrictions ceased to apply and HMRC now treat protected and safeguarded rights in the same way

There are rules which dictate how a protected rights fund can be used to provide death benefits which take into consideration the member’s marital status at the date of death and whether or not the protected rights fund is being used to provide an income.

If a member is married or has a civil partner

If the member is married or has a civil partner or other qualifying dependants and has not yet started to take a pension then a survivor’s pension must be provided equivalent to 50% of the member’s pension. This is because protected rights are meant to replicate State benefits as far as possible.

Prior to 6 April 2005, protected rights survivor pensions had to be indexed annually at 3% or LPI (limited price indexation) to counter the effects of inflation. However, pensions payable after April 2005 were not subject to this rule.

If there is no spouse or civil partner

If there is no spouse, civil partner or other qualifying dependant at the date of death, the protected rights fund can either be paid to the member’s estate or to a beneficiary as directed by the member before their death. The pension provider has no discretion to override the member’s wishes.

Annuities

The income from a protected rights fund is normally secured by way of an annuity. If the annuity is in force i.e. the member has started to take the benefits, then if they die and leave a spouse or civil partner it will provide a 50% survivor’s pension.

If an annuity is in force and the member dies without leaving a surviving spouse or civil partner then the income will either cease or be guaranteed at the full rate, normally for a period of five years commencing from the date the annuity became effective.

© David Room - Ethos Financial Management Ltd

June 2009

01747 812381

Email: David.Room@ethosfm.co.uk