Personal Finance: Come to terms with your policies

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Indy Lifestyle Online
Confused? That could be the aim of some pension providers' literature.

Nic Cicutti cuts through the jargon

Getting to grips with financial products means wading through reams of incomprehensible gobbledegook. It is hard not to conclude that much of the language is deliberately employed to baffle policyholders: typically, they only learn the true meaning of certain terms when the clauses containing them are used against them.

Here is a handy guide to explain some of the jargon that appears in these two pages and when discussing common financial products.

Capital or initial units: When you invest in a policy, the money typically buys units which rise and fall according to investment performance. The "initial", or misleadingly named "capital", units are those that apply in the first year or two of a policy being taken out. They involve higher charges of up to 5 or 6 per cent a year. No matter how long you keep a policy going and how low charges may fall on subsequent years' units, they will continue to remain high on those first units.

With-profits policies: This is where an annual bonus is attached to a policy and cannot be taken away. At maturity, a "terminal" bonus is also attached, which can form up to 60 per cent of the entire policy's final value. The aim of this strategy is to "smooth" stock market ups and downs.

Unit-linked policies: These match direct stock market performance more closely. They may deliver higher performance but also involve investors taking more risks in the short term.

Disclosure regime: In 1995, companies were forced for the first time to provide their clients with details of how much would be taken out of a policy in charges, including commission, and what the effect of this would be on the value of their policy at certain key moments in its life. Disclosure is supposed to be policed by the Personal Investment Authority (PIA), the financial watchdog. But the regime has come under increasing fire for being confusing and for failing to ensure that companies cut some of their more outrageous charges.

Transfer or surrender values: If you halt contributions into a personal pension you cannot ask for the money back. A transfer, therefore, is when you decide to switch a policy from one provider to another and involves the original provider setting a "value" on the amount you can move over. This transfer value is affected by last-minute company charges, which may be hefty.

Surrenders, on the other hand, are possible for policies such as with- profits endowments that are linked to mortgages. Again, the amount paid at the moment of surrender is likely to be affected by heavy initial charges. It is also likely to be low because very little maturity value is attached to it. Generally, if it must be disposed of, as long as a policy has been held for more than seven years, it makes sense to sell it instead of surrendering it. There are several companies specialising in this market.

Paid-up value: If you cannot encash a personal pension and do not want to transfer it, the only other option is to leave it "paid-up". This way it will remain invested by the original provider and will be paid out at the agreed maturity date.

One problem may be that charges involved in leaving a policy paid up may outweigh the heavy cost of transfer. It always pays to consult an independent financial adviser on the relative merits of either strategy.

Key features document: There are two stages involved in handing information to the client. The first, at the point of sale, is when non-specific information about a policy is handed over. This allows for rough comparisons between one policy and another.

Information about charges that are specific to that client and the wording of the policy are sent to investors as part of a "key features" document. The client should have 14 days in which to cancel a policy if he or she wants to.

Projected rate of return: Companies pitching for custom are allowed by regulators to assume certain rates of growth for their policies. This should not be taken to mean that a policy will deliver those returns: it is purely a device that should then allow clients to see what effect charges will have on a range of policies, assuming the same rate of growth for all of them.

Persistency rates: These refer to the percentage of people who decide to keep paying premiums into a policy rather than let it lapse. Thanks to rules demanded by the new disclosure regime, the rates are now officially calculated at the end of one, two and three years.

As more statistics come in it will be possible to know what happens several years down the line. At present, almost one quarter of polices bought from salespeople are lapsed within the first two years.

Tax relief: This is granted to personal pension contributions at the "marginal", or higher rate of tax paid.

In effect, if you make a contribution of pounds 100 into a pension, the taxman will pay pounds 23 of that amount. If you are on the 40 per cent tax band, a further 17 per cent can be reclaimed from the Revenue.

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