Millions of people with money locked up in pension funds are now free to move them, and SIPP providers are pitching hard for the money. But many people will be better off staying put.
From October 1st, people with ‘protected rights’ pension funds have been given the right to transfer their funds to schemes such as Self Invested Personal Pensions (SIPPs). As much as £100 billion is held in protected rights funds and SIPP providers such as Fidelity and Hargreaves Lansdown have been pitching hard for people to transfer money to them.
Protected rights funds were accumulated from National Insurance rebates obtained by people who ‘contracted out’ of the State Second Pension (formerly SERPS). The aim was to secure a larger pension than they would have obtained from the state by investing in funds and shares. In most cases, the crash in financial markets means that if you contracted out you will now be worse off than if you had stayed contracted into S2P.
The rules forbid you from buying back in in respect of the past, though you can contract back into S2P for future contributions, and most advisers now recommend staying in S2P to almost everyone. But now that you have the freedom to move your accumulated funds, does it make sense to transfer the money to a plan where you have a wider choice of investments and can hope to make up at least some of your losses?
SIPP providers claim that it does make sense. Fidelity claims its research shows that at least a third of people with contracted rights funds will switch to a new plan and another third will consider doing so.
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Charges are a key issue
Low-cost SIPP providers such as Fidelity and Hargreaves Lansdown essentially provide their plans free of any administration charges. All you have to pay is the annual charges of the funds in which you invest. So on the face of it this looks a good deal. But in fact for many people charges will be lower on the protected rights plans they currently hold. Many insurance company plans have annual charges of about 1%, whereas the annual charges in most of the funds available within SIPPs are 1.5% or more. So you will only benefit from the switch if you pick funds that produce better investment results than the investments within your current protected rights fund.
That is certainly feasible. Many of the insurance companies’ ‘managed funds’ in which protected rights funds are invested have shown at best mediocre performance over the long term. But improving on that is not just a question of moving from one fund to another. If you transfer to a SIPP, you will need to create a portfolio of investment funds that both aims to generate higher returns but also limits downside risk to a level you are comfortable with. The closer you are to your intended retirement, the less risk you are likely to want, in which case there is also less scope for earning higher returns. SIPP providers offer portfolio planning tools that enable you to build your own portfolio, but in the end you are doing this yourself and you won’t be able to blame any losses you incur on them.
So transferring protected rights to a SIPP only makes sense if you are prepared to put time and effort into managing your own investments. It is not a one-off buy-and-forget decision. You are becoming your own pension fund manager.
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Watch for penalties
The other important factor in the decision is transfer penalties. Many insured contracts contain penalties for transferring before your intended retirement date. Those penalties can be as high as 25% of the value of the fund. Again, the shorter the period to your intended retirement, the less scope there is for making up the loss involved in a penalty and the more likely that you’ll be better off staying put.
People with protected rights plans investing in with-profit funds may well find that insurers are applying a ‘Market Value Reduction’ penalty following the latest slump in share prices.
The Financial Services Authority is concerned about transfers and has reminded financial advisers that they must determine ‘whether there is a genuine need for the investment flexibility and control associated with a SIPP, a clear explanation of the costs involved, and how the recommendation meets a customer's needs and attitude to risk.’
Where you do not use an adviser, these requirements are met merely by the issue of general risk warnings and disclosures of costs. Still, these are issues you should consider very seriously.
For many people, the insured contract they are in may offer investment options that enable them to improve their returns. Whatever the fund you are investing in at the moment, review it with the following guidelines in mind:
• The younger you are, the higher the proportion of your fund that should be invested in shares, since these will provide the highest returns over any period of 20 years or more.
• The nearer you are to retirement, the greater the proportion of your fund that should be invested in fixed interest.
• If you are prepared to take greater risks to secure higher returns, consider funds investing in natural resources or emerging markets.
• If you really want ‘buy and forget,’ use ‘lifestyle’ funds where the manager gradually moves into lower-risk assets as you near retirement.
If you are uncertain about taking on the management of your own pension, then consult an independent financial adviser.
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