Money: Upheaval in pensions

New tax breaks make personal plans even cheaper, says Pamela Atherton
Plans for new low-cost pensions got a big boost last week when the Government announced proposals for a pounds 750m extra tax break.

The move will give tax relief on the first pounds 3,600 of pension contributions each year, regardless of whether the policyholder is making the payments out of earned income or not.The tax relief would operate in the same way as mortgage tax relief, with basic-rate tax taken off at source. Higher- rate taxpayers are given relief at the end of the year.

The move will be particularly helpful to women who have given up work to bring up children, or to those who are acting as full-time carers.

The consultation paper also suggests integrating current personal pension schemes with the stakeholder plans due to come into force in 2001. Higher earners who want to save more than pounds 3,600 a year will still be able to in the same pension scheme - knocking out a main potential problem with stakeholder pensions. The effect is likely to be reduced costs on any scheme sold as a personal pension.

Even before last week's tax news, stakeholder plans were sending shock waves through the insurance industry. Only a few firms are likely to survive as lean, low-cost pension providers over the next 10 years. Having grown fat on the once enormously profitable business of selling life assurance and pensions, the industry is experiencing a rude awakening.

The Government has said it intends to set an overall 1 per cent cap on charges for stakeholder pensions - something now unheard of, and which few providers could meet. The main problem is that almost all financial advice is given on a commission-payment basis - you don't pay anything for the advice but a slice is taken out of what you pay into a pension and given to the person selling it. A 1 per cent cap will make it impossible for advisers to make a living unless customers pay upfront fees for advice.

The pensions industry is frantically lobbying the Government to raise the 1 per cent limit on charges so there is some leeway to pay for advice. Reports last week suggested there may be room for manoeuvre, but the overall cost of a stakeholder-style pension is going to be way below most plans now sold as personal pensions. These carry various charges - to pay for administration, fund management and advice - that can total be-tween 5 and 10 per cent a year.

And, in the run-up to the advent of stakeholder plans, the Financial Services Authority has said only pension contracts that can be converted to stakeholder plans "without material disadvantage to the policyholder" should be recommended by financial advisers and insurance sales teams.This rules out traditional plans with hefty upfront charges that mean your plan may be worth less than you've paid in for the first few years.

In a flurry of activity behind the scenes, pension providers have swiftly withdrawn expensive contracts and replaced them with more competitively priced policies (many still exceed the 1 per cent cap).

Other providers are promising not to claw back the high commissions (that they are still offering to their sales forces and IFAs) in the event that policyholders convert personal pensions into stakeholder contracts.

Figures from the Personal Investment Authority show that about one in five personal pension holders cease making contributions within the first two years. Meanwhile, pension providers are having to compensate investors for the pounds 12bn personal pension mis-selling scandal of the late 1980s and early 1990s. Within five years, there could be as few as half a dozen insurance company pensions to choose from.

SAFE SCHEMES

The following are good, cheap contracts available now from firms likely to survive in the competitive pensions market.

Legal & General - personal pension

Scottish Widows - personal pension

Axa Sun Life - Select plan

Barclays - personal pension

CGU - Lifestyler pension

Norwich Union - Early Transfer plan

Source: Paul Smith Associates

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