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Personal pensions after stakeholder

What does the future hold for personal pensions in a stakeholder world?

The individual personal pension rose out of the ashes of the section 226 contract back in July 1988. Until then, individual pensions were the domain of the self-employed and those in non-pensionable employment were not attracted to them in any large numbers.

The reason why they survive to this day is they continue to provide a key benefit compared with personal pensions. Namely, that in most instances, they pay a bigger tax-free lump sum. So they continue to this day and many self-employed people top them up a the end of each tax year.

Will the personal pension have advantages compared with stakeholder that will mean individuals will continue to save for retirement with them?

The same Inland Revenue detailed regulations governing stakeholder pensions will apply to new personal pensions that are started from April 6, 2001.

So, from a benefit structure, contribution limit, etc, perspective, there appears to be no advantage for the personal pension. But in the area of additional benefits, for those with personal pensions started before April 6, 2001 there will continue to be some advantages.

One of the principal differences between the two will be in the structure and level of charges. The stakeholder regulations set a maximum charge of 1 per cent and preclude the use of bid/offer spreads and other types of front-end load. Personal pensions will continue to be able to be structured in this manner and to charge more than 1 per cent. Will consumers accept being charged more than a flat 1 per cent AMC for a personal pension?

The key issue is whether the additional benefits provided are worth paying for. Some observers argue that access to external fund managers has been impossible to deliver within the 1 per cent charge.

Certainly, where a personal pension provides access to a vast array of fund managers – each would acquire a very small share of the total funds – it is difficult to see how they could afford to charge a sufficiently low fee to the pension provider to enable them to come within the 1 per cent limit.

So for consumers who want to be able to choose from a large number of fund managers without the inconvenience of changing stakeholder providers each time, the personal pension seems to have a place.

Although this will be threatened as funds under management within stakeholder pensions grow and fund managers become more willing to accept a lower margin in order to join a multi-fund manager stakeholder platform.

Even now for consumers wanting a limited choice of fund managers on a stakeholder platform, it is possibleto achieve this. Some potentially very large stakeholder schemes, such as the TUC arrangement, have access to two fund managers and only charge 85 basis points.

For individuals with current personal pensions, there is unlikely to be a mass transfer into pensions. The exit penalties on most regular-contribution personal pensions mean the costs of transferring to a stakeholder are prohibitive.

For people with single-premium personal pensions or where no exit penalties exist on regular-contribution plans, there is a strong possibility of transfers being made out of personal pensions into stakeholder.

One area where personal pensions will continue to flourish will be in the form of the self-invested personal pen- sion. The additional facility to utilise JOM 101 to enable investment in commercial property, company shares, etc will mean this product will continue. Hybrid and deferred self-invested personal pensions are likely to decline. Consumers will tend to invest through stakeholder pensions and benefit from the lower charges until they need to utilise the self-investment facility when they will transfer the stakeholder funds to the Sipp.

The income-drawdown personal pension is also likely to be less affected by stakeholder. The stakeholder regulations recognise that pro- viding drawdown within the 1 per cent limit is unlikely to be possible and therefore allow the cap to be exceeded.

People who have saved for retirement through a personal pension and for whom income drawdown is suitable are more likely to continue using the personal pension to draw down rather than switching to a stakeholder scheme that offers the same facility.

One aspect that might save mainstay personal pensions could be that they may be the only way of saving for retirement using a competitive with-profits fund. There is growing concern within the industry that with-profits stakeholder could be very difficult to achieve. The ringfencing regulations mean that with-profits is likely to represent a poor investment as the lack of capital within the fund will severely limit the ability to smooth investment returns.

The continued availability of a traditional with-profits fund within a personal pension, that fully utilises the free assets within the life fund provides consistent investment returns, is a major advantage compared with stakeholder pensions.

The final area in which existing personal pensions, started before April 6, 2001 may benefit is where they include additional benefits.

The current regulations allow up to 5 per cent of net relevant earnings to be used to provide life insurance benefits.

Under the new regime, affecting stakeholder and personal pensions started after April 5, 2001, the limit on life insurance premiums will be set at a maximum of 10 per cent of the pension contribution.

So for someone on national average earnings of £20,000 they could currently pay £1,000 a year for life cover. In contrast, if a typical person paid £1,200 a year into a stakeholder pension they could only pay £120 a year for life insurance. So, for those people that have a life insurance element already included in their personal pension they could be less restricted in increasing their cover in future years than someone starting a stakeholder pension.

For those with waiver of premium benefit, the current personal pension regime is likely to continue to be more advantageous than from post-April 5, 2001 plans.

Waiver under a personal pension will continue to attract income tax relief although, in the event of a claim, it is treated as taxable income.

In contrast, under stakeholder pensions, waiver will no longer attract income tax relief although the benefits will be tax-free. For many the current tax regime on waiver will continue to be of more advantage and so they will pay further increases into personal pensions, where waiver had been included as a rider benefit.

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