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Clause and effect

I am 22, single and working as a junior accountant in a growing practice where I hope to obtain a partnership.

I am a member of a group personal pension arrange ment which is sponsored by my firm and contributions are expressed as a percentage of salary. I have got the scheme members&#39 booklet but I find it very difficult to identify exactly what the level of charges are and how they might affect the eventual fund. Could you explain the way in which these arrangements work?

I have examined your plan, which is a contract of a type similar to many on the market today.

My company has many years of experience in arranging retirement strategies for many varied types of client.

The overriding issue which occurs time and again and causes the most problems is the inflexibility of the traditional insurance company plan which levies a high proportion of charges at the beginning of the savings period on the basis that this is a long-term contract.

In your case, it is assumed that contributions will be paid for 39 years. I understand your confusion when the section in the booklet relating to the costs of running the scheme is expressed in language not readily understood by those in the industry, let alone the saving public.

To quote: "In addition to the difference between the offer and bid prices of units …the number of units allocated in respect of regular contributions in the first 12 months following commencement of such contributions will be reduced annually, on the anniversary of the commencement, at the rate of 5 per cent pa compound.

"A similar reduction will apply to the units allocated in respect of the first 12 months of any increases in contributions …A policy fee is also charged."

There follows an explanation covering some six clauses describing various situations where the charges are modified, culminating in a final reservation that charges and fees can be changed by the company following a period of notice.

You asked me to outline how this affects your ability to accumulate sufficient funds to provide a reasonable income in retirement.

The insurance company deducts the lion&#39s share of its charges covering sales, marketing and setting-up costs at the outset. A significant proportion of your contribution, therefore, cannot be invested.

The proportion deducted is higher for the longest savings periods, that is, the younger you are, the bigger the percentage you pay as each 5 per cent deduction compounds the loss over the period to retirement. In order to present a more favourable picture, they express the charges and deductions in a way that leads savers to assume that the nominal "fund value" illustrated each year is available.

The real value of the amount invested is only assessed accurately when a transfer value is requested. The diff erence between these two figures is not, as commonly believed, a penalty but the true expression of the costs that have been applied to your regular contributions. The nominal "fund value" is based on the assumption that you will continue to save, uninterrupted, to the selected retirement date, which few people actu ally complete.

The position with contributions based on a percentage of salary is even less attractive, as the insurance company treats each small increase as if it were a new contract on which is levied a new set of initial charges. This happens every single time the regular contribution is increased, which in your case could be every year for 39 years. This obviously reduces the eventual size of the fund and your retirement income.

A more revealing document is the single sheet, which all companies are required to produce, which is the warning covering the effects of early transfer. This tabulates the actual deductions made and is based on a growth assumption of 9 per cent a year. As you can see, even after five years and including growth, you have not yet achieved a profit. If you look at the figures at the 10-year point, the effect of the charges is such that the amount you have contributed has only increased by 13.6 per cent. As I pointed out, this applies to each and every increase.

How do you plan your future when your actual fund size is such a mystery? The low level of investment becomes apparent in the following circumstances:

Early retirement before the selected age.

Ceasing or suspending contributions.

Reducing contributions.

Transfer to another provider.

Modern life is full of change and the unforeseen. People change employers, even industries. They become redundant and fall ill. Investment performance can become disappointing enough for you to want to change the investment house. Your pension planning must allow for these eventualities.

This is not strictly a group scheme. It would be more accurate to describe it as a group payment system for individuals in common employment. If you leave your employer, you may want to continue contributing to your plan. However, it is likely that any new employer may resist contributing if they have a similar arrangement with another provider. This is to ease administration problems. Understandable but unhelpful.

In the future, you may want to stop work for a short time. Starting a family or returning to full-time education are just two possible reasons. It is also not uncommon for people to suffer ill health and take early retirement.

For companies to hide behind the long-term nature of their contracts is no longer acceptable practice and many advisers are using more flexible, lower-cost plans without any of the drawbacks I have detailed. Convincing your employer to review your present arrangement may prove very profitable for you and all your colleagues.

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