By GRAHAM FROST 15/09/2006
It is no secret that, as a Nation, we’re facing a pension crisis. The root cause is that few are saving sufficiently towards retirement to stand a good chance of generating a reasonable income when they get there. However, this is only half the story; even if you are saving a healthy amount can you really trust the pension you’re contributing into?
The quality of the pension(s) you use could have a far bigger impact on your retirement than you might expect. For example, if Pension A returns just 1% less each year than Pension B, perhaps due to higher charges or poor performance, Pension A’s fund would be around 20% smaller than B’s at age 65 (assuming contributions start at age 25).
Fortunately the general quality of pensions available has improved significantly in recent years. The introduction of Stakeholder Pensions in 2001 has led to lower charges and greater flexibility across most pension types, while falling Self-Invested Personal Pension (SIPP) charges mean the ‘Rolls-Royce’ of pensions is no longer the preserve of the rich. This means that with careful analysis you should be able to find a pension that meets your needs while offering excellent value for money. But what about your existing pensions? The key points below should help you ascertain just how good, or bad, they are.
Charges
The only charge allowable under stakeholder pensions is an annual charge capped at 1.5% (1% after 10 years). By contrast, even just 10 years ago it was not uncommon for a typical personal pension to suffer charges as follows:
- Contributions for the first two years would be classed as ‘capital units’ and suffer an annual charge of 4% throughout the life of the pension.
- Subsequent contributions might have a 1% annual charge
- The underlying funds have a 5% bid offer spread and 1-1.5% annual management charge
- If the pension is transferred then the pension provider could look to recoup costs not yet deducted between now and retirement, so transfer values can be penal.
- A lot of older pension plans even levy additional charges if you need to stop paying the premiums or retire early
The reason for such high charges is a combination of paying very high initial commissions to financial advisers and providers making a healthy profit on such schemes. We suggest you review the charges on your plan, especially if you suffer from capital units.
Performance
Solid investment performance could be well worth paying charges for. But most Insurance Company pensions have been restricted to a narrow range of funds – all managed by the pension provider themselves. As the figures below show, Insurance Company funds have tended to under-perform comparable unit-trusts: -
|
ABI |
IMA |
UK All Companies |
80.2% |
113.1% |
Global Equities |
44.0% |
70.5% |
Europe ex UK |
126.7% |
141.8% |
North America |
45.4% |
65.5% |
Cautious Managed |
80.9% |
112.9% |
Balanced Managed |
73.4% |
78.9% |
UK Smaller Cos: |
92.6% |
174.6% |
Far East ex Jap: |
19.7% |
48.8% |
Japan: |
-14.0% |
3.8% |
Lipper figures show ABI sector average (excluding
externally managed funds) vs equivalent IMA sector
over the last 10 years (to 31 August bid to bid with
income reinvested) |
Some Insurance Companies have now begun to add a wider range of funds to their new policies – many managed by external Investment Houses. But this does little to help the majority of plan-holders with ‘legacy policies’. So Norwich Union’s Your Pension Select now offers 90 funds; but their old ex-Provident Mutual plans will give you access to only 7 funds – all managed by themselves - that have performed poorly in key areas (e.g. UK equities).
Many older plans were invested in ‘with-profits’: a medium that 20 years ago was both popular and relatively successful. In recent years, however, the sector has declined with many with-profits funds now offering little exposure to growth stocks and poor prospects for returns in the longer-term.
Of course, older plans are not all bad. Some, for example, have valuable Guaranteed Annuity Rates that would be lost on transfer. A few even have additional life assurance benefits – if you opted for these at the time. And of course, you should check what penalties would be levied if you transferred to an alternative.
SIPPs
One alternative is to use a Self Invested Personal Pension (‘SIPP’) with a ‘Funds Supermarket’. With this approach, there is no need to compromise on any holding, or choose from a restricted range, as these offer access to anything up to 1,000 funds. The performance of fund managers can then be tracked. And when necessary, funds can be switched with a minimum of paperwork or expense. This way, it is possible to remain invested with the industry’s better performing managers.
A SIPP holder can make the investment decisions themselves, perhaps with the help of on-line investment tools and research. Alternatively, for larger funds an investor might appoint a professional adviser. Details are available on: http://www.bestinvest.co.uk/pensions/sipp.htm
A SIPP is not always the right option for everyone. But if you have older pension policies, a SIPP can be the ideal route for breaking free from the restrictions and poor track record of some of the older Insurance Company offerings.