Your Money: The pensions that could give grief to your partner

Hidden danger may be lurking for up to a million holders of old- style self-employed pension policies, and in particular their unsuspecting beneficiaries if they should die. Clifford German reports on a little- understood clause which could leave dependants of policy-holders with little to show for their loved ones' saving commitment.

The policies under scrutiny are so-called pure endowment policies, and are sometimes known as "return-of-premium policies" because they give back only the premiums already paid, either with or without interest, if the beneficiary dies before he or she takes a pension.

A recent case was raised on Moneybox, the BBC programme, by Helen Saunders, a widow whose husband died just four months before he reached the age of 65 and his Scottish Amicable policy was due to mature. The policy would have been worth pounds 27,000, which would be used to buy a pension when it matured, but Mrs Saunders only received the premiums that had been paid in over the years, a paltry pounds 8,200.

The galling thing is that if Mr Saunders had known he was going to die he could have cashed in the policy at any time after he reached the age of 60 and quite legitimately claimed a much larger sum. But he did not know and nobody advised him of the potential risk; certainly not Scot Am, which issued the policy, or NatWest Bank, which sold it to him.

Most of the personal pension policies sold since 1986 have been invested in unit trusts, and they are return-of-fund policies that literally guarantee to return the current value of the fund if the person who took out the policy dies before he or she retires. But most of the policies sold as pension funds to the self-employed before the introduction of personal pensions were return-of-premium, and even the best ones only paid back the premiums plus a possible interest rate of either 3 per cent or 5 per cent if the policy-holder died before the maturity date.

Scot Am received some stick as a result of the publicity, but it is only fair to say that most old-style policies sold by the established insurance companies were return-of-premium only, and the premiums would have been significantly higher if they had guaranteed to return the full value of the funds if the policy-holder died.

The prudent thing to do would have been to take out a term assurance policy at the same time as the pension plan, and the life policy would pay out if the policy-holder died before reaching retirement and top up the widow's benefit. Maybe the sales executives who sold the policies did advise the buyers to do just that. But it will be difficult to prove at this distance of time, and the pension plan premiums would obviously have been higher.

Some return-of-premium policies were still being sold as late as 1990, so anyone who bought a pension plan before that date would be well advised to check, with their independent financial adviser or with the company that provided the policy, just what sort of policy they have, quoting the details from the policy itself. Some life companies will allow return- of-premium plans to be converted to a full return-of-fund basis, although this will usually involve reducing the amount the policy will pay out if the policy-holder lives to retirement.

David Aaron, the senior partner of the independent financial advisers David Aaron Partnership based in Woburn Sands, says anyone with a return- of-premium policy needs to obtain figures from the life company on whether a switch is possible and if so what the relative payouts would be, and then decide whether to change. It may well be cheaper to stick with the existing policy and take out some life assurance to cover the gap until the policy matures.

But life assurance premiums will inevitably be higher than they would have been when the policy-holder was younger and fitter, and in some cases it may be best to take a lump sum plus a reduced pension. Most pensions can be taken without any medical reference after the policy-holder reaches 60, and in some professions it can be done even earlier. The worst-case scenario is to do nothing and hope for the best.