Section 32 Contracts

It would be useful if you have already gone through the units 96.1, 78.1, 78.5 and 78.6.

What is a section 32 conract? It’s a single premium pension contract, meaning no regular contributions can go into it. Fundamentally it is an occupational pension scheme, and its money purchase or defined contribution which means there’s a fund.

Importantly, where did that single premium come from? It didn’t come from somebody’s savings. The money to go into a section 32 contract has to have originated from a previous occupational pension scheme. And that means nothing more or less than a pension scheme relating to employment.

So the fund originally built up in an occupational scheme. This can have either been a final salary scheme or from a money purchase scheme, but not from any form of personal pension. That matters because now we move on to what are the essential features of a section 32 contract, which informs whethere we decide to transfer out of the scheme.

It came from occupational, still is occupational, whether it looks like a personal pension or not. What distinguishes it from a personal pension is firstly how the tax free cash is calculated, the lump sum. Importantly it is not simply 25% of the fund as with personal pensions. With occupational schemes tax free cash is a complex calculation which is related to a lot of factors which we won’t be looking at right now. The big thing here is how much it might be as a percentage of the fund. When you find it out, is it likely to be more than 25%, less than, or what? The reality is the majority of times it will be more than 25%. In fact there are a significant number of schemes where you can take 100% of your pension as a tax free lump sum. Many individuals though also have tax free cash of beween 35 and 75% which is obviously a big benefit over personal pensions. This is irrelevant of whether it has come from a final salary or money purchase scheme.

The second big reason for being in a section 32 applies only where it came out of a final salary scheme in the first place. If that does apply, you’ve got an underlying promise, an underpin about how much the scheme will bring you. The section 32 is a fund and obviously the investment performance determines how much you get back from the fund. If you’re going into a unit-linked contract and your section 32 starts at say 30 grand, it can go higher and lower over time with fluctuations up and down and hopefully trending upwards in the long-term. If you have the underpins that come from a final salary scheme, you get what is called a GMP or guaranteed minimum pension.

In a section 32 if we capitalise the value of the GMP it may start at say 20 thousand pounds and will go up over time, and represents the minimum amount that will be paid to that individual at any one time. If you can see in some cases the GMP line is actually above the investment performance line, if you were to take your benefits or retiring at this point you would receive the higher rate of the two, which in this case is the GMP. So whereas in a normal money purchase scheme the individual might think ‘well its just my luck’ to start drawing benefits when the fund is performing poorly or the stock market is low and other investment areas have gone through the floor but not to worry, because it brings you back up to the red line. It’s in tablets of stone so the insurance company has to meet that value.

On the other hand, if your money purchase value is high and the fund is doing well, if the green line is up there then you don’t have to worry about anything because the guarantee is met and more. Now different insurance companies have set up their section 32s in different ways but that is true for the vast majority of them. A very small minority give you the guarantee and the fun of the fair, the upturn on the investment as well but they are quite rare.

So the two main reasons for going into a section 32 are higher, sometimes much higher tax free cash than you’d get in a personal scheme, and the GMP which is continued from your previous occupational scheme.

So what are we looking for if we’re transferring out of a section 32? Three things. The first is tax free cash. Unless you’re transferring within the occupational environment which is rare, you’ll be going into a personal pension. If you do that glibly and blindly you get 25% tax free cash which is very likely to be a good bit lower than what you have currently, a bad transfer. If the GMP is 140% of the fund for example, then you’ll get 25% of you tax free cash is you switch to a personal scheme, but you lose 40% of total benefits. This is because in a section 32 contract the GMP must be met first and is in the form of pension only, so tax free cash can only be taken from the value of the fund above the guarantee. So the higher your guarantee is, the less flexibility you have to take a large lump sum at retirement. If your guarantee is above 90% of the money purchase value and the client particularly needs tax free cash for whatever reason, you may consider transferring to a personal scheme.

Section 32 Contracts

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