Personal finance: Pension revolution

New portable retirement savings will be cheap and flexible, says Isabel Berwick

WHAT AMERICANS dream up we will surely copy, even when it comes to preparing for retirement. We may not want to spend our twilight years in an "evergreen" community in South Carolina, but we are about to get American-style choices about about how we save for retirement.

Last week the Government announced new ways of building up a pension, and it acknowledged the influence of America's "401(k)" retirement savings plans. These are portable "pots" of money built up using contributions from employers and employees. The cash is invested in mutual funds, the American equivalent of unit trusts. Last week's announcement paves the way for Britons with personal pensions - and the new stakeholder pensions - to buy into unit and investment trusts. (Some have dubbed these plans "Lisas" - lifetime individual savings accounts. The Government doesn't like that title, and it no doubt confuses the issue.)

The plans are not a competitor to the stakeholder pensions announced last year. Buying unit or investment trusts to fund your retirement is just an alternative way to save, with the same tax relief on your contributions as you get from other schemes.

Life may never be the same for the giant life insurance companies which have dominated the UK pensions market. Saving through normal collective funds will give us more choice and cheaper deals. Those who want to keep track of their funds will be able to check their value in the papers every day, and work out how much retirement cash has built up. The charges on unit and investment trusts are clearer and the package will be cheaper and have the potential to perform better than many pension offerings from life companies. The box shows how badly the average general UK equity pension fund has underperformed against the FT-SE 100 index in the past 10 years.

The model for the British 401(k) of the future may be the pensions already run by a handful of investment trust groups, including Flemings and Edinburgh Fund Managers. These are cheap and flexible. The Edinburgh scheme allows investors to pick from Edinburgh's own funds, and some run by other managers.

Not surprisingly, the Association of Investment Trust Companies (AITC) is delighted by the Government's announcement. Its director general, Daniel Godfrey, says: "This is the death knell for the traditional high-charging, inflexible, opaque pension product." Investment trust pensions haven't made the headlines until now because they are cheap and don't pay high commission levels. Flemings pays 3 per cent of the first year's premium as commission to independent advisers and then a 0.5 per cent fee each year. In contrast, life companies can use their reserves to pay out amounts which are, say, 70 per cent of the buyer's first year's premiums. There are special commission deals on offer to favour IFAs who get 60 per cent more cash than the published rates.

Unit and investment trust firms have long felt this "indemnity commission", which life companies are allowed to pay out of their cash reserves, is unfair. The Government's paper is being taken in finance industry circles as a mechanism to knock down these high commission rates, and bring an end to hefty start-up charges. The pension mis-selling scandal is uppermost in Labour's mind, and the life companies have taken most of the blame. By re-routing pensions business to "untainted" unit and investment trust companies, the life companies will have to sharpen up their act.

Legal & General's head of pensions, Tony Filbin, said: "The industry was preparing to live in a lower-charging environment with the advent of stakeholder pensions. The Treasury announcement last week accelerated that process."

He believes life company pension funds can offer the same, or better, performance, than unit and investment trusts.

The new pension investment rules should be in place by the end of the year, and we can expect to see the big-name unit trust PEP managers, such as Mercury and Fidelity, entering the personal pensions and new stakeholder pension market. These firms already manage huge volumes of cash for company pension schemes, so they will be well placed to offer low-cost portable pensions (the new "stakeholder" pensions) which invest in unit trusts.

By chance, Perpetual chose last week to announce the launch of its unit- trust based personal pension plan. It did not know the rules were to be changed and had worked for two years to set up the business, using a complex "shell" life company. The firm hopes to win business through IFAs even though it pays much less commission than traditional life insurers.

Perpetual's head of pensions, Fiach Maguire, chairman of the pensions advisory group at Autif, the unit trust trade body, is "delighted" by the plans. He believes investors are ready to take control of their own retirements. "The Treasury has been impressed by the US mutual fund industry's success in educating investors. They have persuaded people into equity investment. I hope we can get people thinking of how much they have in their `pension account' and to understand what it is worth."

The full text of the Government's announcement `Helping to Deliver Stakeholder Pensions' is on the Treasury website at: www.hm-treasury.gov.uk

Contacts: Edinburgh Fund Managers, tel: 0131-313 1000; Flemings, 0500 500161; Perpetual, sold through IFAs.