The pros and cons of moving your pension
Some £4.7 billion of retirement funds have been withdrawn from defined contribution (DC) schemes since the pension freedoms were introduced last year – £2.5 billion of which was taken as cash lump sums and £2.2 billion through income drawdown products. And, of the people that have accessed their pension, around half have switched provider to do so, according to the Association of British Insurers.
Pension switching means moving savings from one provider to another without losing the tax advantages, which pensions offer. When a DC scheme – which most workplaces offer these days – is moved to another provider the term used is ‘pension switching’. However, the terms ‘pension transfer’ may also be used, although this typically refers to moving a defined benefit (DB) pension to a DC scheme.
The topic of pension switching has hit the headlines due to pension freedoms. While the Chancellor’s announcement in 2014 made it sound like you would be able to access your cash with a single phone call, it’s actually more complex than that.
Make an income
To turn a pension into an income you either need to buy an annuity or go into flexi-access drawdown, which allows you to access it as a lump sum or as an income. However, drawdown didn’t exist pre-1995 so any pension taken out before this date will either require you to buy an annuity or switch it to enter flexi-access drawdown. This need not necessarily be with a new provider: you may be able to move it to a more modern plan with your existing provider.
David Trenner, technical expert at Intelligent Pensions, says: “Anything written since 1995 may allow it. Of the people retiring now, I would imagine they have had a pension for more than 20 years and so will have a plan that pre- dates drawdown.”
Mr Trenner says while some providers will allow you to switch to a different pension that offers drawdown, those who have their savings with ‘closed book’ insurance companies will have to move to a different pension provider.
Closed book means the insurer no longer accepts new business, so will not have products for retirees to switch into.
The ability to use drawdown isn’t the only reason to switch pensions, it is also a way to consolidate a number of pensions into one place.
Claire Trott, head of pensions technical at pension specialist Talbot and Muir, says transfers open up options for retirees to make the most of their savings. “Transfers give members options to choose all different aspects of their pension scheme,” she says. “They can use it to change the way in which they pay for their scheme, what assets they can invest in, what benefits will be available at retirement and even what benefits they can leave behind.”
However, while there are benefits to switching pensions, there is also a number of risks for those who do not check the small print of their pension contracts.
Many older pension contracts came with investment, growth or income guarantees and by switching pensions any right to these guarantees – which may be very generous – are given up. Recent figures from the Financial Conduct Authority (FCA) show that more than 68% of guaranteed annuity rates (GARs) have not been taken up. The rates paid on these schemes were put in place when gilt yields – which are used to calculate annuities – were so much higher, meaning they can pay out double or more than what is available from the best conventional annuities today.
If you want to take advantage of GARs, you have to buy the annuity offered by your provider. You may also have to retire on a specific date to get the deal, but it’s important to be aware of what is on offer before you dismiss it.
Other pension contracts offer a guaranteed investment return or growth on the pension pot. Jarrod Ellis, financial planner at Delta Financial Management, says those whose pensions are linked to with-profits contracts could be giving up bonus payments by switching.
With-profits differ from normal funds in that returns are not based solely on performance but smoothed over the term of the investment, so in good years some of the profits are held back to pay out in bad years. Bonuses are also built up and paid at certain dates, with a final bonus being paid when the term of the contract is up. By cashing in the contract early, retirees give up their rights to a bonus.
Mr Ellis warns some with-profits funds have “specific bonus rates” that may have to be cashed on a pre-set retirement day and if claimed the day before or after would be lost.
Retirees don’t just have to consider the benefits they will lose when they switch, but also how much the move will cost. Terminating a pension contract before the pre-set retirement date could result in an exit fee.
The Treasury has said it will cap exit fees from March 2017, but it is yet to confirm what the cap will be. FCA data suggests around 16% of savers would be subject to an exit fee if they left their pension, with 3% to 4% of savers facing charges of 5% or more.
Once you have weighed up the pros and cons of switching and decided you want to go through with it, the first thing to do is gather all your pension policies together.
Mr Ellis says it is worth reading through the details and contacting the provider to see if there are any guaranteed benefits. “If you phone the provider to get information, make sure you get all the answers to your questions in writing,” he adds.
“We spoke to one provider who said there was no GAR on a policy and when the client dug out the policy documents and we compared it to what we had been told, there was a GAR. There was a fault on the provider’s system.”
If your pension contract does have benefits, such as a GAR, and the value of the benefits is more than £30,000, then the new rules require you to take advice before you switch.
However, it is worth taking advice on switching whether you have benefits to lose or not as an adviser will be able to recommend what type of pension plan you should switch to.
This will depend on what you want to do with the money. “If you’re looking to cash the whole pot in on the transfer, then it is simply a case of looking for a reputable provider and establishing who is the cheapest,” says Ms Trott. Aviva for example, charges no set-up or withdrawal fees, but savers would need to pay an ‘underlying product charge’ for the time their money was invested however this is only likely to be a matter of pounds. Royal London similarly would only charge an annual management charge of 0.9% based on the length of time your money was invested.
Ms Trott adds: “If you want something more long term, then there are many more issues to consider, such as ongoing charges and range of investments.
“The range of investments available is one key driver for transfers; the new scheme doesn’t have to offer everything, just everything you need.”
If this is just some low-cost funds, then a personal pension from an insurance company may be sufficient, but more investment choice will be available with a low-cost self-invested personal pension (Sipp) that offers access to the entire universe of funds, as well as shares for those that want to invest directly in the stock market. These are available from online platforms including Hargreaves Lansdown, Interactive Investor and Fidelity.
(Click on the table below to enlarge)
Wealthier investors looking for more esoteric investments, including property holdings or AIM-listed shares, may want to consider a fully comprehensive Sipp, but they are expensive if you don’t take advantage of all the investment options. These are available from companies including Dentons, Talbot and Muir, and AJ Bell.
Mr Ellis says the cheapest way to go into flexi-access drawdown is to switch to a pension on a platform – these will be available with many insurance company pensions and from low-cost Sipps.
Platforms are an online account where you can access all your investment ‘wrappers’ such pensions and Isas. Through platforms, which are typically low-cost, you can invest your pot in funds and change your investments as you see fit. Money in drawdown can also be seen and managed on the platform.
When a plan has been decided upon, the pension switch can take place – but there is one more hurdle to jump. The ideal way to transfer is ‘in specie’, which means the investments held are transferred automatically without the need to cash out of the old pension investments and reinvest in the new scheme.
However, not all switches can take place in specie and those that can take longer. This means you will have to decide whether you want to come out of the market and incur the charges from reinvesting in the new scheme.
“In most cases, should the transfer be coming from a personal pension or an employer’s scheme then you will be making the transfer in cash because it isn’t possible to move the asset to another provider,” says Ms Trott.
“This will involve them selling [investments] and sending the cash, usually electronically, to the new scheme.
The new scheme will have usually asked what to do with the funds when they get them, although some may just hold it in a bank account until they are given direct instructions.”
She adds that Sipp transfers are more likely to be done in specie. “This is good if you still want to hold [the old investments] in the new scheme, but can have a higher charge. It does mean that you are not subject to changes in the market should something happen between selling them in one scheme and buying them in another. If you are having a complete change of investment strategy, it will be simpler, easier and probably cheaper to sell them before transfer.”
Pension switching can take time, especially if transferring in specie. Mr Ellis says to factor in between eight and 12 weeks from approaching an adviser to the switch being complete and expect it to cost between £1,000 and £1,500 – though complex scenarios could cost more.
“Pension advice is like surgery; you cannot just say to a surgeon: ‘operate on me’. The doctor has to take a risk assessment and understand your medical history,” says Mr Ellis. “You won’t be able to just take your money out.”
Five reasons to switch pensions:
- Increased flexibility when making retirement plans
- Potentially lower costs if switching into a cheaper scheme
- Potentially greater investment choice
- Provision of a lump sum death benefit that is paid to a spouse on death
- Access to flexi-access drawdown under pension freedoms.
Five reasons NOT to switch pensions:
- The loss of valuable benefits such as guaranteed annuity rates
- Guaranteed bonus rates in with- profit linked pensions
- Penalties for switching away from your existing pension provider
- No evidence of better returns
- The need to cash out investments to switch, which could be detrimental, especially during periods of market turmoil.
“I want to restore an old Bentley”
Mr Hughes, 55 (pictured above), is in the process of transferring his pension in order to realise his dream of setting up his own business.
Mr Hughes, an engineer who is a client of Matt Wiltshire of Niche IFA Chartered Financial Planners in Newport, has around £300,000 in a pension with his employer but the scheme does not allow him to access as much of his savings as he would like so his adviser is helping him to transfer to the AllTrust Services Sipp.
Under the new scheme, Mr Hughes plans to keep some money invested by taking his 25% tax-free cash “to fund my intended business venture and using the rest to live on for a period of time until my business ventures are up and running”, he says.
Using the money he takes from his pensions Mr Hughes plans to buy and restore an old Bentley and turn it into a wedding car.
“I have recently become incredibly disgruntled with work and feel that setting up my own business would be a far better way of heading into retirement,” he says.
“I plan to purchase and restore an old Bentley into a wedding car, purchase a trailer to ship vintage motorcycles and cars, and possibly even a small shop where I could sell motorbikes. As you may guess cars and motorbikes are a great passion of mine.”
He says he wanted to finish work “immediately” and set up a new business, but adds it would not have been possible without the new pension freedoms.
“This has offered a route to a happy retirement by enabling me to start a couple of businesses which I am passionate about,” says Mr Hughes. “I am looking forward to working with Matt and transfering the pension so I can begin the next stage of my life.”
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
Not to be confused with an early repayment charge (ERC). Exit fees are levied on top of ERCs, which are a method of clawing back lost interest on a loan repaid early. By contrast, exit fees are charged for the administrative work this entails. They are charged as flat fees, from £150 to £300. However, in January 2007, following mortgage lenders surreptitiously raising fees sometimes by fivefold, the Financial Services Authority (FSA) intervened and most mortgage lenders removed exit fees from new mortgages. If you paid exit fees on your mortgage before January 2007, you may be able to claim them back.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.