DC contracting-out is to be abolished, eventually (no earlier than 2012), under provisions in the Pensions Bill currently before Parliament. In the context of Simplification, though, it doesn't make much sense to do this without also removing the special rules governing protected rights. The Government asked the industry to come up with a way of squaring the circle, ie scrap the protected rights rules without jeopardising survivor benefits. Unsurprisingly, no magic solution has been forthcoming, so the problem has been parked on the DWP's extensive array of back-burners. It's been folded into the joint DWP/Treasury review of the working of the Open Market Option for annuities, announced at the Pre-Budget Report in November 2006 (see The Annuities Market [PDF], paragraph 4.18), due to conclude by the end of 2007.

The background to this is a DWP consultation [PDF], promised in the May 2006 Government White Paper Security in retirement: towards a new pensions system, which was conducted last autumn (see Aries report). This focused on the possibility of reforming or removing the rules applying to protected rights, already built up or held in DC schemes, at the point of abolition of DC contracting-out.

By common consent, if achievable this would simplify scheme administration and reduce costs. The rules (eg on where protected rights can be invested or where they can be transferred) require protected rights to be treated differently from other scheme rights, so they have to be tracked separately. Where the member is married or is a civil partner at the point of annuity purchase, a survivor benefit must be provided: the member has no choice. Few people understand that separate rules apply to the protected rights element of a pension pot, which doesn't help.

Retaining the rules on protected rights already accrued, once DC contracting out is abolished, for the future would perpetuate the current difficulties caused by these rules. Removing all of them is the only way in which the whole of the 'pension pot' could be treated in the same way. In a formal response [PDF] to the consultation, published this week, the Government recognises that, unless the rules are removed, schemes will have to continue to track protected rights separately and HMRC will have to continue to be informed by schemes when protected rights have been secured. However, the Government also recognises that there are concerns about the potential impact on survivors, especially women, of removing the rule requiring provision of a survivor benefit. Without doubt this is the critical difficulty.

The four-week consultation period ended on 13 October 2006, and included a workshop attended by 13 industry representatives. As well as putting forward their views at the workshop, a number of those attending also provided a written response. In total, there were 37 written responses.

The condoc asked if there was another way a survivor pension could be assured for surviving spouses and civil partners whilst allowing for simplification. Of 24 responses to this question, one suggested that protected rights be 'bought' back into the state system. (From the date of abolition of DC contracting-out, scheme members will begin to build up full entitlement to the State Second Pension.) It is unclear whether this option has been seriously considered by the DWP. Other respondents apparently felt that any alternative to the present rules would mean trading one restriction for another and could not, therefore, be achieved without undermining the principle of simplification.

In the meantime, via an amendment inserted at Second Reading (Clause 15(2)), the Government has taken a power in the Pensions Bill to abolish or vary by regulations some or all of the DWP rules that determine the use of protected rights. The use of this power will be decided once the review of the working of the Open Market Option for annuities publishes its findings. Until this decision is taken (which won't be this year), no firm proposals will be made.