FOOL'S EYE VIEW
Check Your Pension!

By James Carlisle
September 16, 2002

We're all happy to move our mortgages around, but which personal pension to go for seems to be a decision that we only like to make once. Having bought, or much more likely, been sold a pension product, we tend to forget about the whole scary business and just continue to chuck money into it, content in the knowledge that 'at least I'm doing something'.

This lack of discernment among consumers about personal pensions is a matter for concern at the Financial Services Authority and, last week, one of their occasional papers (1.7mb pdf) looked into the problem. It appears that, in any one year, only 1% of people with personal pensions switch them to a new provider. That compares with a figure of about 10% each year for mortgages (and even as much as 2% per year for bank accounts).

The difference with mortgages and pensions is that with the former, we can see an immediate and tangible benefit of switching providers. With pensions, on the other hand, everything is hard to quantify and far away in the future. If anything, though, your retirement planning is more important to get right than your mortgage.

The Fool's Pension Centre explains more about how personal pensions work, but the main factor that distinguishes one from another is how much you can expect it to grow over the years. Industry practice for this, quite rightly, is to assume a rate of growth for the investments that a fund invests in (generally speaking this is the stock market, for which a 7% rate of growth is used) and then deduct from this all the fund's charges. You can think of the charges as being like a leak in the pension fund, with money dripping out at a certain rate each year.

So, taking an expensive personal pension, you might project total annual growth of 4% -- made up of the 7% per year investment return, less 3% per year in charges. If you take a 'stakeholder pension' on the other hand, which has its charges capped by regulations at 1% per year, then you might expect annual growth of 6% per year -- being the same investment return of 7% per year, less 1% per year in charges.

These differences might sound small, but the projected effects over the life of a pension fund are enormous. Contributing £200 per month to both (including the Government's tax rebate) over 30 years, the expensive pension would grow to about £138,000, while our stakeholder pension would be worth nearly half as much again -- around £196,000. Translating this into benefits (assuming an annuity rate of 7%), the expensive pension might give you a lump sum of about £34,000 and an income for life of about £7,200. The stakeholder might be expected to provide a lump sum of about £49,000 and an income of £10,300.

Sticking to the wrong pension can cost you a fortune!

So check your pension!

There are two main points to make about this. First of all, if you've got a pension, then you should make the time, very soon, to find out whether it's a good one or a bad one. The number one factor affecting this is the level of its charges. So get your pension documents out and see how much they're charging you each year. If you can't work it out from the documents, then call them up and ask. Make sure you get a figure for the total annual charges of the fund.

If the charges come to more than the 1% limit on what you might have to pay on a stakeholder pension -- and, if its not a stakeholder pension, then the chances are that they do -- then it will make sense to look further into things.

Essentially you have three options:

(a) leave things as they are;

(b) leave what's in the current pension there, but stop putting money into and start a new pension for your future pension contributions (called making the old pension "paid up"), or;

(c) transfer the accumulated pension fund to a new pension and make your future contributions to that new pension fund.

Which of these options is best for you depends on the growth you expect in the future from the different pension funds (essentially dictated by the charges, as shown above) and any costs or penalties involved in transferring one pension fund to another (as in (c) above). With a little careful playing around, you can get an idea of how things might play out with the help of the Motley Fool's Compound Interest Calculators (you'll be wanting Calculator 1 - How Will My Investments Grow Over Time?). You need to do is work out what might happen under the various different scenarios.

Scenario (a) -- Leave as is

So, for 'Scenario (a)' above, in which you're leaving things as they are, you enter your total monthly pension contributions (including the Government's tax rebate) into the top box, the number of years until you plan to retire in the second box, the up-to-date value of what's in your pension fund in the third box (called the initial capital sum) and the assumed rate of growth in the third. As I've said, the industry standard figure for investment growth is 7%, but 9% would be closer to what's happened in the past, while 5% would be more conservative (try using some different numbers), but from this figure you have to deduct the annual charges.

Scenario (b) - Make 'paid-up'

For 'Scenario (b)', making the old policy paid up, you're splitting your pension into two parts: one for the old pension (left where it is) and one for your future contributions to a new pension. So you need to do two sums and add the two together. For the old pension, put '0' in the top box (you're not making future contributions), the number of years to go in the second, the current value of the pension fund in the third box and the old pension's assumed growth rate in the fourth.

For the new pension, put the monthly contributions (including the Government's tax rebate) in the top box, the number of years to go in the second, nothing in the third (the new pension is starting from scratch), and the assumed growth rate for the new pension in the fourth.

Add together your projected values for the old pension and the new pension and that's what this option might be expected to achieve for you.

Scenario (c) - Transfer lock, stock and barrel

For 'Scenario (c)', you're moving the accumulated pension pot to a new pension, but it may be a lower value than what was in the old pension because of transfer costs and penalties. So, into the first box, enter the amount of your future monthly contributions and, in the second, enter the number of years to go. In the third box, you put the actual amount that you're able to transfer into the new pension (that is, after any transfer costs and penalties) and, in the fourth, you put your assumed growth rate for the new pension.

Compare the different outcomes

Comparing the outcomes for different scenarios and assumptions should give you an idea of what might be best. If it looks like it might be best to start a new pension, with or without a transfer of the accumulated pension fund, then start by talking to the new pension company to see if they, and any projections they might do for you, agree. If they do, then they'll talk you through the process of switching the pensions. If you're unsure about things, then it might be worth taking financial advice. However, we'd suggest you stick to fee-based advisers that don't have an incentive to sell you expensive pensions!

Make sure you get a good pension in the first place!

None of this is straightforward, but it matters -- A LOT. So you need to keep an eye on your pension, just as you might with a mortgage. One thing is for sure, though, you stand to save yourself a lot of time and energy -- not to mention money -- if you make sure you get a good pension in the first place!

Probably the three most important criteria for a personal pension are: (a) it has nice low charges (and therefore a relatively high projection for long-term returns); (b) has a good spread of investments (an ' index tracker' is the best spread you can get in the UK stock market and most stakeholder pensions are index trackers), and; (c) doesn't penalise you if you do want to switch pensions further down the line. All these factors point towards ' stakeholder pensions'.

More: The Fool's Pension Centre