FOOL'S EYE VIEW
Choosing a Stakeholder Pension

By Rob Davies
April 5, 2001

Carburton Street, London -- Tomorrow marks another escalation in the complexity of the pension industry with the formal start of Stakeholder Pensions. These join occupational, personal and state pension schemes, as well as SERPS and SIPPs, each with separate rules and regulations. In the near future the State Second Pension (to replace SERPS) and Individual Pension Accounts will be added. So the question is what do Stakeholder Pensions offer that makes them better than the rest?

The simple answer is that they offer low charges and flexibility. To qualify as a Stakeholder Pension registered with OPRA, the Occupational Pensions Regulatory Authority, annual charges must be less than 1%, with no initial fees or charges for transfer. The annual fees must include all broker fees involved in running the fund. However, the prevalence of soft commissions, and the ability for funds to trade shares net or gross (i.e. with or without commission), means that policing it is going to be extremely difficult. And when I spoke to OPRA it admitted it wasn't sure how it was going to enforce this.

Nevertheless, the big advantage claimed for Stakeholder Pensions is their flexibility. It is possible to continue funding this pension even when not working. Even better than that, the Government still gives you the tax credit even if you are not working.  That is worth £792 a year to every child and non-working person in the country, and there are 30m of them. It is true that much of that will go back in tax when the pension is used to buy an annuity, the income of which is taxable, so it is more like a loan.  The exception to that is that is the 25% tax free lump sum you get on retirement, so non-workers still get a hand out from the Government. Anyone in this situation would be well advised to get a Stakeholder Pension.

Then there is the annuity thing, which has been discussed at length elsewhere on the site, but it has been given very little prominence in all the documentation on Stakeholder Pensions that I have seen. Just to recap, the fund that is built up in a personal pension (and a Stakeholder is just a different variety) has to be used by law to buy an annuity before the age of 75. An annuity is not an investment; it is a mechanism to give a guaranteed income (taxable, mind) for the remainder of your life. So it cannot be used to pass wealth on to the next generation.

Finally there are all the restrictions that surround Stakeholder Pensions. The maximum gross contribution is £3,600 a year, equivalent to £2,808 net if you are taxpayer and already in an occupational scheme. To be honest that isn't a fat lot and won't buy much of an annuity when the time comes. If you have no other pension then you can contribute more, up to 40% of your income if you are aged over 61 and earn more than £95,400. In practice most people will be allowed to subscribe much less than that because of the age and earnings allowances. Nevertheless, it remains far more attractive than the conventional personal pension plans because of the cap on fees and absence of transfer charges. For this group Stakeholders are a good idea.

Assuming you choose a Stakeholder Pension which one should you go for? You might think there was nothing to differentiate them if they all charge the same, but that is not the case. A table in last weekend's Financial Times listed many providers of Stakeholder Pensions with their charges. However, it needs to be interpreted with care. While quite a few of them proclaimed charges of less than 1%, in all cases bar two as far as I could determine the lower rates only applied to fixed income (i.e. bond) funds. The lowest charge is 0.5%. However, we know that over the long term equities give far superior returns to the alternatives of cash or bonds. So we should not be seduced away from equities by a reduction of 0.5% on the charge. The only two funds offering equity investments with charges of less than 1% are Marks and Spencer (LSE: MKS) at 0.7% and the TUC at 0.85%.

But life isn't quite that simple. The other variable in the selection process is the type of fund the pension is invested in. Our preference is always for tracker funds because you know exactly what you are buying. Marks & Spencer offers a FTSE 100 tracker as one of its four choices, but many of the other firms only offer managed funds or, horror of horrors, with-profit funds. The problems at Equitable Life are testament to how obscure they are. At least two other firms offer recognised trackers: Legal & General (LSE: LGEN) and Barclays (LSE: BARC). The carrot with Barclays is that is waiving fees altogether until January 1st 2003.

Trying to make pensions simple is a thankless task, but hopefully this has provided an outline of the pros and cons of a Stakeholder Pension. For more details click through onto our special Stakeholder Pension section in our Pension centre. And then, as always, Do Your Own Research.

More: Stakeholder Pensions section of the Pension Centre 
Duelling Fools giving both sides of the Stakeholder Pension story
OPRA list of Registered Schemes