Is your do-it-yourself pension safe?
Greater flexibility and investment choice have made self-invested personal pensions (SIPPs) a popular choice for retirement savings.
But, while the extra features give them the edge for many investors, it's important to appreciate how safe, or not, your money is and what could happen if things go wrong.
Although robust regulation of financial services companies means it's unusual for a firm to go bust, it can happen. "Anyone who had savings with one of the Icelandic banks that collapsed back in 2008 will be aware of the importance of understanding the protection that is in place," says Tom McPhail, head of pensions research at Hargreaves Lansdown.
But while protection for savers is straightforward, with a simple cap of £85,000 per person per savings institution, the complexity of SIPPs means you need to grapple with different limits and types of compensation.
For starters, there are two different scenarios that could result in a claim for compensation. Greg Kingston, head of marketing at Suffolk Life, explains: "The way SIPPs are structured, compensation may become payable either if your SIPP provider fails or the provider of the underlying investments fails. Each case would be treated slightly differently."
When it comes to the failure of the SIPP provider there are two different types of Financial Services Compensation Scheme (FSCS) compensation that could apply.
For insured SIPPs offered by insurance companies such as Aviva, Legal & General and Standard Life, protection is 90% of the value of your SIPP. Where it's a trust-based arrangement, which is the case with the more traditional providers such as James Hay and Suffolk Life, the maximum amount you can claim for under the FSCS is £50,000.
Although this appears to put the trust-based arrangements at a disadvantage, in reality these limits wouldn't normally come into play. Any assets you hold within a SIPP are ringfenced and held separately from the SIPP provider. This means that, if the SIPP provider fails, your SIPP will be safe.
Any creditors will be unable to access your money and, although it will take time, and probably aggravation, you will eventually be reunited with it when it is transferred to another provider.
However, there are instances where compensation may come into play, such as where the provider has been acting improperly and kept the money within its own accounts. But McPhail says this is extremely unlikely. "SIPPs have been regulated by the Financial Services Authority (FSA) since 2007 and, although it's not guaranteed, this means the checks and balances are in place to prevent anything like this happening," he says.
Indeed, the FSA is in the process of tightening up the rules for SIPP providers. Current rules mean a SIPP provider only needs to hold sufficient funds to run their business for six weeks but, as there are fears this would be inadequate to cover the time taken to wind down the company, the FSA is running a consultation with a view to extending this.
But, even though the FSA consultation is likely to lead to improvements in consumer protection, disentangling your pension from a provider that goes bust is not straightforward. Murray Smith, sales and marketing director at pensions firm Mattioli Woods, explains: "There would be a lot of heartache and pain.
"You wouldn't be able to make contributions, buy and sell investments and, worse, if you were drawing down a pension from your SIPP, this would be put on hold. It makes sense to conduct thorough research into the financial strength of a SIPP provider, not just the size of its charges, before you select it."
The SIPP companies are getting better at providing this type of information, with many producing due diligence reports that cover the financial aspects of the company. Kingston recommends asking for information such as the auditor's report, the company's track record on profitability, and its profit and loss records.
"We're also being asked about the philosophy of the company and who owns us. You need to know it's going to be there as long as your pension is and that the directors aren't all about to sell the business and retire," he adds.
The range of investments that can be included within a SIPP means the protection arrangements are even more complex, with different rules applying to each type of investment.
For any products issued by firms authorised by the FSA, protection from the FSCS is available. How much you would receive if a firm was declared in default varies according to the product type.
As an example, while you'll be covered for up to £85,000 if you are holding a bank deposit in your SIPP, if you are holding investments such as unit trusts or structured products, these will be subject to the investment business rules, which are capped at £50,000 of compensation.
Further, an investment issued by an insurance company, for instance a trustee investment plan, would be considered long-term insurance, and FSCS compensation would be set at 90% of the value, with no upper limit.
Although the probability of an investment company failing is slim, it's sensible to keep these limits in mind when building your SIPP portfolio. Exceed the limits and the amount you'd get back as a percentage of your investment can start to fall.
"Diversification of the underlying holdings is key," Smith explains. "As an example, if a client is interested in using structured products within their SIPP, we try to ensure they spread the underlying counterparty risk by investing relatively small amounts with a large range of banking institutions."
As well as helping to ensure your assets are protected, diversification is also a sensible investment rule. Spreading your investments across a range of different providers, assets, sectors, regions and investment styles helps to reduce the risk that if one performs badly, it won't wipe out your portfolio.
"Don't put all your eggs in one basket is the classic investment maxim but it's worth following for the investment performance as well as the protection," adds Andy Zanelli, head of retirement planning at Axa Wealth. "Stick to your asset allocation and hold a broad range of different investments that are suitable for your risk profile and objectives. It's the best way to make money in the long term."
But, while protection is in place for these products, it's possible to hold a variety of investments in a SIPP that aren't issued by firms authorised by the FSA. For these, protection may be in place but it's on a case-by-case basis. As an example, with some of the more mainstream investments such as offshore funds you may have some protection in place through the investment company's home state regulator.
However, where a recognised regulator isn't in place it can be more tricky. For instance, if you hold a property in your SIPP and it burns down you might be able to recover the value if buildings insurance was in place. If not, you might need to consider a legal case if someone was liable.
Because protection isn't guaranteed, Zanelli says it's important to factor this in. "There are lots of esoteric investments that can be included in a SIPP that are unregulated. The protection, or lack of it, should be a critical part of investment selection," he says.
Financial Services compensation scheme
The Financial Services Compensation Scheme (FSCS) is the UK's compensation fund of last resort for customers of authorised financial services companies. If a firm stops trading or has been declared in default, it can pay compensation to affected customers.
How much protection is in place depends on the type of product:
- Deposits - £85,000 per person per banking group
- Investment business such as unit trusts, OEICS - £50,000 per firm per person
- Long-term insurance, including some investments issued by insurance companies - 90% of the claim, with no upper limit
You are entitled to claim for all relevant categories if an authorised firm is in default, up to any limits that are in place. For example, if you hold unit trusts and a savings account with a firm in default you could claim up to £85,000 under the deposit scheme and up to £50,000 on the investment business scheme.
Compensation is only payable where the firm is in default. It doesn't apply if the value of your investment has fallen, although you may be able to seek compensation if you were given unsuitable advice.
To speak to the FSCS, call 0800 678 1100 or visit its website fscs.org.uk for more information.
This article was written for our sister publication Money Observer.
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.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
This type of insurance covers the structure and fabric of your property – the bricks and mortar, not the contents (for which you need contents or home insurance). If you have a mortgage, the lender will insist you have a suitable buildings insurance policy in place. Many lenders offer their own building insurance policies, but you don’t have to buy it from your own lender but you have the option of shopping around. The insurance covers you for the rebuilding costs, not the market value of the property.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).