Just how safe is our savings safety net?

I usually give warnings about shady stockbrokers, ‘easy money’ schemes and rip-off investments that promise the world. This time is different. There’s still a warning, but it’s about gaps in the Financial Services Compensation Scheme (FSCS), the safety net that we would come to rely on should any licensed British financial business goes bust.

The near-collapse of Northern Rock turned the spotlight on the compensation scheme last year. Many people realised for the first time that they could lose hundreds – or even thousands – of pounds, because the scheme paid out only a percentage of the losses and not every penny, and there was a ceiling to the amount anyone could claim.

The government and the Financial Services Authority (FSA) did a quick bit of tinkering and changed the rules. So if a bank or building society goes broke, savers could claim 100% of their money up to £35,000. In October 2008, this limit was increased to £50,000 to calm fresh fears of bank safety.

This will cover most savers without any problem. And big savers can spread their money across a variety of separately licensed banks to ensure that all their savings are protected.

However, there are three gaping holes in this system that hardly anyone knows about.

The first is that anyone buying or selling a house is likely to have far more than £50,000 zipping through the banking system on moving day. Imagine the nightmare you could face if your bank closed its doors on that very day and you couldn’t complete your purchase. A promise of £50,000 compensation to be paid months later would not be much consolation if you and all your furniture were out on the street.

The second loophole applies to executors and administrators winding up the estate of someone who has died. Their job often involves turning the deceased’s assets into cash for payment to beneficiaries. The cash is held in an estate bank account, awaiting distribution. If the bank failed, and the money was lost, the executors could find themselves sued by the beneficiaries for having chosen the ‘wrong’ bank.

However, it’s the third and final gap that’s potentially the most serious. Billions of pounds have poured into self-invested personal pensions (SIPPs) since the rules were simplified in 2006. As company final salary schemes have closed, SIPPs have soared in popularity. But what would happen if something went wrong and a SIPPs manager collapsed? In theory, pension investments should be held separately from the manager’s own business assets, yet how many times have such safeguards proved less than reliable in practice?

The blunt fact is that SIPPs are a very long-term investment.

A young person starting a SIPP today could well be looking at a pension pot worth half a million pounds or more in the run-up to retirement – if the cash turned out not to be there on retirement day, compensation of £50,000 would not even scratch the surface.

There’s no easy answer to these issues. For executors and homebuyers, the authorities are likely to recommend insurance to bridge the gap between the compensation limit and the amount at risk. But no one has yet devised a solution for SIPP-savers, though the government is hoping to come up with a solution.

In some ways, this warning is more serious than usual. It’s easy to think we’re safe when we deal with a group that’s been vetted and licensed by the FSA, partly because we believe the compensation scheme will pick up the pieces if anything goes wrong. Sadly, however, this isn’t the whole truth.

Tony Hetherington is Consumer Champion of the Year 2007

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