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Is it ever good advice to recommend that a client ditches a guarantee?

A client has some money in a pension which has investment guarantees but I am unhappy about the service of the pension provider. Is it ever a good idea to transfer out of these investments?

This issue tends to crop up with old-style pensions with a portion in with-profits on which there are guarantees, normally in the region of 4 per cent annual growth.

A guarantee is not to be given up lightly. Indeed, as an adviser, your neck is firmly on the line if you recommend that a client loses guarantees.

There is no one right way to deal with this and the whole issue becomes more clouded when the pension plan invests only partly in guaranteed with-profits, with the other part invested in a series of exceptionally poor performing funds. Even when policies allow fund switches, the alternative funds’ performance can be pretty lacklustre.

A restricted choice of funds can also bring further frustrations when trying to match the risk profile of the funds chosen with of the client’s risk tolerance. It can become impossible to choose good funds within the existing pension.

Some client circumstances highlight this dilemma neatly. A client called Sarah is in her mid-30s and has a significant portion of her pension money in a high-charged contract in closed funds. Around a third of the pension is in a with-profits fund giving a guarantee of 4 per cent a year.

The other two-thirds are invested in a couple of remarkably poorly performing funds. Our research concludes that there is no reasonable expectation that these funds or, indeed, any of the other funds from this particular provider are going to improve.

Given the particularly erratic markets we have had, 4 per cent a year until retirement date might seem like a pretty good bet but what Sarah is gaining on the guarantee she is losing through significant underperformance in he other funds. In this case, after discussion with Sarah, her decision is to move the entire fund to a self-invested personal pension, accepting that she is going to lose the guarantees but giving her a far greater choice of funds.

This is a brave decision, particularly as coming out of with-profits incurs a pretty significant penalty. This highlights that we have a great responsibility to make sure the pension works well for Sarah by recovering the costs of the transaction and starting to make some real money for her.

Another client, Nicola, has around £400,000 in a series of pensions of which £2,000 has guarantees. In this instance, although her timescale to retirement is less than five years, the advice is to consolidate and improve her pension position and forgo the guarantees on this small portion. Again, there are arguments for leaving this particular portion of the pension separate but it is bundled in with poorly performing funds which make up the majority of the pension fund.

However, for most clients who are older and have a shorter period to retirement, a 4 per cent guarantee can be more critical. A client may decide that depending on the portion they have in with-profits, they should accept underperformance of the other funds because the guarantees are more valuable to them, given the timescale.

Philip has less than 10 years to retirement and his pension has 50 per cent exposure to guarantees of 4 per cent a year. He is a fairly cautious investor and, notwithstanding that the other half of the money is restricted to pension funds with one particular provider, his decision is to stay as he is but diversify the nonwith-profits portions into other funds. In this case, it is a sensible decision as Philip has funds outside pensions which can give a balance to the funds that he has within his pension.

The case of Sam’s pension is very interesting in terms of the guarantees as she wants to retire at 55. She is now in her late 40s but the guarantees on some of her pension only kick in at 65.

There are two options. Sam may decide to diversify the non-guaranteed part of her pension into a Sipp and leave the guaranteed growth pension where it is or she could move the whole lot into a Sipp. If the first option is taken, she can use the other pensions that she has and, indeed, other assets, to cover her retirement from 55 to 65 and the guarantees will then kick in at 65.

I am not entirely happy with the fund choices within the pension that has the guarantees but we can choose some passive-style funds that complement more exciting choices in other investments.

This is a workable situation for the client as she will be putting in significant amounts of money into the pensions which we can properly diversify and, thus, the portion which she has with guaranteed growth rates will diminish in importance for her retirement planning.

These scenarios show how different the advice is depending on the client’s temperament, risk profile, term to retirement and proportion that is in guaranteed funds.

There really is no one solution that one can apply to all cases.

Amanda Davidson is a director of Baigrie Davies


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