Contracted Out Pensions Hurdle Rate

By Tom McPhail | 18 Sep, 2008 

If you are one of the 6 million to 8 million people who has been contracted out of SERPs through a Personal Pension, then this may be of interest to you; it relates to the hurdle rate on contracted out pensions.
 
There are various different definitions of the term ‘hurdle rate’ but for generalised purposes, this one seems to fit as well as any: ‘The minimum return on investment necessary to cover all costs associated with a project’. Where you want to express this in terms of projected investment growth, then what you get is a yield figure; the average annual return required to deliver the target you are aiming for. In other words, this is a measure of how fast your rebates in your Personal Pension need to grow by every year, to match the benefits you gave up when you chose to contract out.
 
So according to an actuarial review of contracting out prepared for the Financial Services Authority back in 2005, the hurdle rate on contracted out policies is pretty steep.
 
It turns out that at the lowest end of the spectrum, for young high earners, there is still a hurdle rate of 6.6%, and this assumes that you are only paying 1% a year in charges; with many old personal pensions charging perhaps twice this figure, the hurdle rate is up at 7.6% a year, which is challenging but not unachievable. As your age increases though, so does the hurdle rate; for a 40 year old man on average earnings the hurdle rate is 7.6% (assuming just 1% a year in charges).
 
What this means is that if you want to have any hope that your contracted out pension will get close to matching the SERPs pension you gave up, then you need to make sure you are getting the most out of your investments.
 
The forthcoming rule change which will allow contracted out funds to be transferred to a SIPP from 1st October which will allow a much wider investment choice and so is a welcome opportunity for those happy to make their own investment decisions to pursue this goal.