It has been hailed as a pensions revolution. On Wednesday millions of people
with pensions stuck in dreadful life insurance funds will be given the
freedom to take control of their investments.
This is when up to £350 million held in protected-rights pensions will be
given the green light to move to self-invested personal pensions (Sipps).
Until now, the funds built up by opting out of the top-up state second
pension (S2P), or its predecessor, Serps (the state earnings-related pension
scheme), had to be invested with an insurance company. The aim was to
protect investors, but performance has, in many cases, been poor.
The Government has decided that the shackles will come off next week,
potentially benefiting up to ten million people.
However, some of Britain's leading insurers are threatening to spoil the
party. Tens of thousands of investors have been warned that, effectively,
they will be barred from quitting their insurance funds by penalties called
market value reductions (MVRs). These are levied on transfers out of
with-profits funds, where a lot of the protected-rights money has been
invested. MVRs are being introduced by a growing number of insurers and can
cut transfer values by as much as a quarter.
Nick O'Shea, of Pharon, the independent financial adviser, says: “The rule
change will be of huge benefit for people who want to take more control of
their pensions. But there is going to be disappointment that a lot of the
existing funds are subject to with-profits MVRs.”
The reintroduction of MVRs just in time for the October overhaul is more a
matter of bad timing than anything more cynical. Insurers apply MVRs after
large falls on the property and share markets to discourage a run on the
funds. Almost all insurers imposed them during the last bear market, but
most had been lifted by the start of this year.
Now they have returned with a vengeance. Standard Life, Legal & General,
Zurich, Scottish Widows, Aegon and Scottish Life all confirmed this week
that MVRs would apply to the transfer of protected-rights funds in some
cases. And with no end to the stock market turbulence in sight, more
insurers are expected to follow their lead.
Guy Vanner, of AKG, the consultancy, says: “If a lot of people start coming
out of these funds, there will be pressure on insurers to reintroduce MVRs.
This will come as a shock to some investors who were unaware that they even
existed.”
MVRs usually apply to every saver in a with-profits scheme, not only those
with protected rights. But their reintroduction is particularly unfortunate
for investors who had been hoping to take advantage of the pensions rule
change. Some will be forced to sacrifice thousands of pounds if they
transfer. Since contracting out was introduced in 1988, many savers will
have built up protected rights pots of anything from about £20,000 to
£100,000, depending on investment performance.
MVRs are normally applied as a percentage of the current value of the
investment. Standard Life, for example, says that the maximum it has been
applying is 25 per cent.
The penalties levied by life funds that have closed to new business -
so-called zombie funds - tend to be particularly steep. But advisers say
that these are the very investors who have most to benefit from a fund
transfer. Returns have, almost universally, been appalling. Malcolm
Cuthbert, of Killik & Co, the stockbroker, says: “As returns are likely
to be much better elsewhere, investors will have to weigh up whether an MVR
is a price worth paying. Some may decide to hold off in the hope that the
MVRs will soon be removed, but the trouble is that you never know when they
will be lifted.”
Some investors will decide that the sacrifice is worth making. Sipps offer
more flexibility, providing access to thousands of investment funds, as well
as individual shares, commercial property and even gold bullion. The greater
freedom gives you a better chance of beating typical insurance-based pension
funds, where returns have been less than dazzling in recent years. The
average unit trust has risen by 80 per cent in ten years, against 62 per
cent for typical pension funds.
However, MVRs are not the only reason why switching may not be
straightforward. Charges on Sipps may be higher than those on existing
pensions. Fidelity, Alliance Trust, Hargreaves Lansdown and Killik offer
some of the lowest-charging Sipps. But watch out for one-off charges for
other services, such as share dealing, and remember that you have to pay
extra for advice if you do not want to choose the investments yourself.
Many life insurers offer a wide range of investment options from top fund managers and changing your fund mix may be a cheaper and easier option. That
does not mean that you will escape an MVR - simply leaving the with-profits
fund is usually all it takes to be hit by an exit penalty.
Some protected rights funds have a valuable guaranteed annuity rate (GAR),
which could be lost on transfer. A GAR could boost your retirement income by
thousands of pounds a year, so you should definitely think twice before
giving it up.
You should also check what will happen once a Sipp transfer takes place.
Though most will welcome your existing fund, they will not necessarily allow
any future contracted-out rebates to be added. You will be opted back in to
S2P automatically.
Tips for Sipps
If you think that investing your Sipp in individual shares is too risky in the
current market turmoil, you could opt for several funds, each one of which
will have a portfolio of many dozens of shares. This will spread your risks
and prevent you from suffering too much financial damage from the collapse
of any one share.
Treat market falls as a friend, rather than enemy. Provided that you are a
long-term investor with a number of years to retirement, you can take
advantage of any share-price falls by buying more shares at a lower price.
If you do not wish to watch the markets constantly to decide when to invest,
you can drip-feed your money into funds by making a regular monthly
investment. By using this approach you will also benefit from what is known
as pound-cost averaging. This is where your money buys more shares when the
fund price is low and fewer shares when the price is high.
It is never rash to dash for cash. You can always park your money in a cash
fund while you decide what your next move should be.
Mark Atherton
Case study: Taking control
Rob Davis, of Ystrad Mynach, South Wales, is preparing to transfer
protected-rights money from a personal pension into a Sipp as soon as the
rules change.
Mr Davis, pictured with his children, Evan, 6, and Esther, 4, contracted out
of the state earnings-related pension scheme in 1992. He has since built up
several pots of protected-rights funds: some in company pensions with
previous employers and also in a personal plan with Friends Provident. He
plans to move these to a Hargreaves Lansdown Sipp next month.
Part of the £20,000 he holds with Friends Provident is in the insurer's
with-profits fund, where payouts have been falling as bonuses have been cut.
Fortunately, Friends Provident, unlike many other insurers, is not applying
a market value reduction to fund transfers.
The 39-year-old says: “The main attraction of a Sipp is the greater
flexibility. There is a degree of risk if you manage it yourself, but with
that comes the chance to invest in shares and almost any fund you wish. You
also have control over the charges you pay.”
Park your money in a cash fund ? Earlier this year I switched my pension fund from equities to a Deposit Fund for safety . Such funds invest in the money market ie. lend to those banks who are now no longer lending to each other !! And there is no transparency in these funds . Low risk ?
Tony Bennett, Haslemere , UK