Many individuals work hard their entire lives, and one of the pay-offs of that is earning a secured pension to make life easier once retired. A pension is a type of fund into which money is paid throughout the years that an individual is employed. After the individual retires from work, periodic payments are drawn out to support that person’s retirement period. Pension plans differ from employer to employer and also vary country to country. Often government pension arrangements are created as additional supplementation to the basic state pension. In the UK, State Earnings Related Pension Scheme (SERPS) is a pension scheme where the amount an individual is paid is dependent upon the amount of years they have worked for their employer, as well as the salary they have earned within a certain period of time.
What Is A SERP? (State Earnings Related Pension Scheme?)
The UK is known as a country whose government looks after their aging population. As such, the UK government provides employees with the option of partaking in a State Earnings Related Pension Scheme (SERP), based on accrued earnings during a specific period.
Originally called the ‘state earnings-related pension supplement’, the SERP was a government pension plan that was contributed to by employers and employees in the time period between April 6th, 1978 and April 5th, 2002. In 2002, the SERP was replaced with the State Second Pension (S2P).
For employees who were paying into the Class 1 National Insurance (NI) contribution between 1978 and 2002, they earned a SERPS pension. These members could also be ‘contracted out’ by their employers. In these instances, employees and employers paid less into NI contributions, thus the employee’s earnings of serps pensions would be virtually non-existent.
What was the Purpose of SERPS?
The purpose of the SERP scheme was to supplement the basic state pension by providing individuals with a pension that was relative to their accrued earnings during that specific time period. SERPS were founded on the principle that all employees would receive a SERPS pension of 25 percent of their accrued earnings. That 25 percent would be above a ‘lower earning limit’, which would approximate the basic state pension’s amount.
The scheme was slowly brought in over 20 years with the intention that people retiring before 1998 would receive a SERPS pension relative to the number of years they were contributing to it. The ‘upper earning limit’ was approximately seven times the lower-earning limit, outside of which earnings were disqualified for NI contributions and SERPS pensions.
Social Security Act of 1986
The Social Security Act of 1986 lowered the SERPS pension from 25 to 20 percent of an individual’s accrued earnings between the lower- and upper-earning limits. Pensions earned prior to April 6th, 1988 remained the same, and the change was integrated for people who were retiring between 1999 and 2009.
The ‘Contracting Out’ Option
When the scheme was introduced, employers with established final-salary pensions could select the option to contract out of SERPS. Employers were allowed to contract out if scheme members were granted a ‘Guaranteed Minimum Pension’. Employers who opted out of the SERPS would pay less into NI contributions.
For the first time, in 1988, constituents of pension schemes were permitted to contract out. Rather than being obliged to provide a ‘guaranteed minimum pension’, the schemes were obligated to pay savings of NI contributions into the pension plan. To incentivize this arrangement, the government made an additional payment into the pension scheme of every instance where the SERP was contracted out in this fashion.
April of 2002 saw the termination of SERPS accrual as it was succeeded by the State Second Pension. This change was instituted with the goal of providing people of lower incomes with a larger pension.
Controversy of SERPS Mis-Selling
According to the Financial Services Authority, many policy holders who contracted out of the state pension may have been victims of pension mis selling and lost funds that deserve compensation. Hence an investigation was launched to investigate the claims that millions of employees had been led astray with the advice to contract out of SERPS.
As the government began to question the long-term affordability of the SERPS, they offered incentives to encourage people to opt out of the SERPS into an Appropriate Personal Pension (APP). The rebates offered by the government as incentives to opting out have since been cut, causing many to question whether it was misleading to encourage people to opt out, as many are now being advised to opt back in.
Ultimately, investigations have shown that mis-sold pension affected some, but not others. For some, returning to the state pension is a favorable option, but for others in different financial circumstances and with different financial needs, the APP option is also beneficial.
Positive Examples of Leaving the State System
While leaving the state caused monetary losses for some, not everyone is in the same financial situation, and for many, APP has its merits.
In terms of cash availability, individuals have the option of taking 25 percent of their pension as tax-free cash from an APP; this is not an option in the Second State Pension. With an APP, the pension is available at age 50, rather than 65 as with the state pension. The accessibility of cash in an APP can be a necessity for people who are ill or facing death in the short-term future. Death benefits also differ between the state and APP as state pensions are provided to widow and widower’s survivors, but unmarried people don’t apply. APPs can be applied to the individual’s estate. Additionally, some individuals simply prefer for their pension entitlement to be under their control, rather than the government.
Sadly, as hard as people work to secure future pensions, there are also scam artists who will work equally hard to steal those funds away. Pension scams take place when an individual is convinced to cash in their pension pot to invest in something that promises a large return. An example of this came with the Serious Fraud Office’s warning regarding a £120m pension scam involving UK-Based self-storage units.
As storage units have recently been hailed as having great investment potential, many people are being convinced to invest their pension pots with the enticing promise of gaining an 8- to 12-percent return. While ‘pension liberation’ scams have always been around, the steady upsurge is partly understood as resultant of government-introduced reforms granting people over the age of 55 more freedom to access and invest their retirement funds.
While more traditional pension scams use the allure of investing in hotels or services in exotic locations, a local approach hailing the investment-return potential of buying individual storage units has also proven effective. Storefirst Limited storage unit pension scams toted the potential of a 14-percent annual return with the purchase of individual units. Basically, the investor was encouraged to purchase a unit from Storefirst Limited, which would then be sublet to a management company that would rent it out.
While Storefirst has denied culpability in the scam, the warning is clear: if you are contacted suddenly by someone promising a large return on a foreign or local investment, think first before cashing in your pension pot and transferring your hard-earned funds.