One of the most important if not the very most important financial decision for any of us is “what to do about saving for pension purposes?” and here I would like to share an industry insider secret with you. This secret is very valuable and could save you a huge amount of money and possible heartache if you choose to heed it, and very few people will tell you what I am about to tell you below.
The secret is that the products you will most commonly be offered offshore as a “pension plan” are no such thing. They are instead just a vehicle in which to accumulate money which may one day be used for income either by drawing down on it, or if you really wanted to buy an annuity with it you could. They will not automatically provide you with future income payments.
However before you get to the stage of spending your accumulated money it is important to understand these savings vehicles are really nothing more than a regular premium life assurance policy with a specified premium payment term, and life cover of 1% more than its investment value in order to qualify it as such. When signing for one of these you are agreeing to make every payment due from the date of inception until the specified maturity date. If you do not meet this requirement the terms are full of penalties and conditions which can really hurt you financially.
It is my experience that most people just want to build up their savings in a cost-efficient and flexible method and I can think of no one I know or have met who wants to be chained to an inflexible scheme which penalises them if they can no longer afford to save what they used to. We all live unpredictable lives and the last thing we need at a time when we might have had a change of circumstances thrust upon us is a lack of flexibility in our savings arrangements. After all saving is supposed to be what you do for the proverbial rainy day and by definition we never know when those rainy days may arrive.
There are several variations on a theme depending on the life assurer involved but what I would like to do here is to take a close look at one of these plans because in my own humble opinion anyone who bought one would have to be either naïve or insane, and yet many are sold around the world each and every month to people whom I’d opine either didn’t fully understand them or didn’t do their homework in full. Here we shall do it together.
Can we first agree that
1) Our aim is to save up some money and have as much as possible available to us when we retire?
2) We cannot with any accuracy predict our own future circumstances?
3) Whatever we are saving is our money and should at all times remain our money with no grey areas?
I don’t intend to single out any particular company’s product as there are usually variations but not massively so, but we have to choose one so I’d like to look with you into one of the typical pension planning vehicles you are likely to be offered offshore, which is Royal Skandia’s Managed Pension Account. (They also have the same product re-labelled Managed Savings Account). According to the brochure they say this is better than their rival’s product so if that is true you can draw your own conclusions when you have read the rest of this analysis.
Right on the front cover of the brochure I downloaded from their website it says that the brochure is not for use in the UK, Hong Kong and Singapore. I believe I am correct in saying that is because it doesn’t contain enough information to satisfy the regulatory standards in force there. Working from the brochures, even to me as an experienced industry professional the exact way the plan is charged and implications is not very easy to follow so let’s look at it together and whilst I’d gladly retract/correct if indeed proven wrong I believe the below to be entirely accurate and if I have in any way misunderstood it then it is because in my opinion the brochures and product guide lack clarity. Only in the adviser’s guide is there a matrix of early encashment charges and they are savage. The Policy Terms talks about them but doesn’t show clearly it in a matrix .... so here it is direct from the guide:
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From the product brochure we can read that the “initial investment period” is 1 month for each year of the term over which you have agreed to invest. We are told that there will be an extra 5% allocated to your investment during this period but we should also remember that every contribution paid in is subject to a bid/offer spread of 7% so you lose part of that extra 5% too, (bid/offer spread just means the difference between what they would sell them to you at and what they would buy them back at), plus an additional 1% annual fee to Skandia and another £5.50 per month “monthly maintenance charge” which is doubled to £11 per month if “the Fixed Account“ is used. I have three of their brochures and they give little detail of the Fixed Account in any of them but seems more to do with if you have stopped paying in but left your money there.(i.e “Paid Up”) In the three product brochures I have there is no clear explanation of this Fixed Account and we have to go right into the Policy Terms to find this. Apparently you can have the smaller of “one half of the value of Allocated Units at their Bid Price: or 90% of the value of the Allocated Units at the Bid Price (ie current value) LESS the early encashment charge (which vary depending on how far into your plan you are but is set out above).
I’d like to just go back to that annual fee for a moment because that is not 1% on each contribution as it is paid but 1% per annum on the whole investment value, so as the pot grows so does the monetary amount of the 1% pa fee. The effect of 1% pa compounded over many years is huge. See for yourself by playing with this calculator http://www.1728.com/compint.htm
Additionally to this we have to consider that the insurer is with the exception of a few in-house funds, just a conduit which collects your money, emphasis on the YOUR money, and will pass it to another fund manager chosen from the funds menu. It must be pointed out that the underlying fund or funds also has/have annual management fees of normally between 1 and 2% and a range of 1.5- 2% pa being the most common. So if we add the life assurer’s 1% pa plus the underlying annual fees of 1.5-2% we have 2.5-3% per annum PLUS the bid offer spreads of 7% on each contribution before we can actually begin to make a profit.
Also the brochure Skandia supplied to me, PDF3461/26-1014, mentions the underlying funds and says:
Discounted initial charges to underlying funds – In many cases to nil.
Now I don’t know how you read that but to me it infers that in more than a few other cases it is not nil, so assuming you had picked funds where it was not discounted to nil, this would mean you were paying Royal Skandia a 7% bid/offer spread, plus 1% annually, plus the underlying fund manager’s annual management fee of typically 1.5% to 2% per annum PLUS an additional fee to get into that underlying fund. All of which has to be covered just to get back to flat on the sum you invested.
If I could then bring your attention to the fact that you may well have 20 years or more to your selected retirement date, let me ask “who of us knows with any degree of certainty what will be our circumstances along the way?” We are at the time of writing in the depths of the global credit crunch aftermath and we can see economic problems galore as the debt which piled up and caused this mess has not gone away. Many of you may have witnessed people close to you who have either lost their jobs or suffered some form of hardship due to this, but even before we had these circumstances it is true to say we never have 100% visibility.
For example I have an old endowment plan myself which was originally designed to mature and pay off my mortgage in the UK. However I left UK in 1992 and haven’t had a mortgage now for the last decade. I am told by the insurer that the plan will not produce enough to clear the original loan value, so as an investment it has also been lousy. If I stop it or surrender it I get hit with penalties so I am forced to keep it going even though I don’t want or need it, and I don’t even need the life assurance it carries.
Not an ideal scenario is it?
Obviously it makes sense when saving to save as much as one can but commonsense should tell us that just maybe our circumstances will change and we may for whatever reason need to change our plans. Maybe we shall return to the UK or other homeland and if we did, whilst it is not illegal to run an offshore savings plan, with the availability of tax free savings plans in UK in the shape of ISA’s or an onshore pension which will give you tax relief, would we be able to afford to fund both? If we stopped the plan to fund the ISA we will be punished financially for doing so. If we keep the plan going and don’t do the ISA we are financially disadvantaging ourselves the other way in that the ISA proceeds would be tax free when we cash them but in UK the offshore life plan proceeds will be subject to income tax.
Maybe we will move from somewhere where we have a tax free income and accommodation supplied to somewhere where we have to pay tax and pay for our own accommodation. Perhaps we shall have a career change with less stress and earn less but be happier?
The possibilities are huge but I guess you get the picture, so let’s just assume you stopped paying in because of a change of circumstances. If you stopped paying in within the preliminary period then your account will lapse with zero value. A bit strong because it’s YOUR money. Imagine for a moment you had paid say £1000 a month for 18 months of a 20 year term and then through no fault of your own lost your job and needed that money back to live on, only to be told “no”. £18,000 wasted.
If you were to stop paying in for more than 3 months the account will become “paid up” and missed contribution charges will apply, although they are kind enough to allow you to make a partial surrender under the penalty free allowances of 1% pa to allow you to fund the premiums you miss. This is apparently called the premium holiday option and will allow you not to pay the missed contribution servicing charge of 8% because you will pay the 8% due on the premiums with money you are paying from your existing pot under the penalty free allowances. So as I read and understand that you are actually taking out money you already paid to get in there and paying again when it goes back in in lieu of missing premiums.
The missed contribution charge is 8% of the missed contributions per year. So if you cannot afford, or do not wish due to a change of circumstances, to keep the plan going for whatever reason you will be charged at penalty rates for not doing so.
What does that actually mean? Assume you wanted or needed to reduce your contributions to the brochure minimum of £350 per month. You can do that but subject to a “missed contribution servicing charge” of 8% pa on the shortfall between what you are now paying and what you were paying. Assume for a moment we came down from £1000 per month to £350 per month. That means you’d be paying close to 10% on the £350 (7% spread +1% annual, + monthly maintenance, + underlying fund annual management charges) plus 8% pa on the £650 pm balance you were no longer paying. Let’s look at what that means for a moment in monetary terms. If you started at £1000pm and through no fault of your own later permanently reduced the plan to £350 per month you would be paying 8% of the balance per month, which is £1000 - £350 = £650 x 8% = £52 X 12 =£624 pa extra charges each year on the money that you were not putting into your plan. In this scenario you’d be still putting in £350pm X 12 = £4200 pa. On that we know you’d pay close to 10% total in charges on the new money going in which is about £400 pa, plus the £624 on money which you were no longer able to pay in. Therefore if we add that together we are up to +/- £1000 pa of the £4200 pa you were putting in lost in charges and plus the 1% annual fee on the pot value which is ongoing as the annual management charge.
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How about if you wanted to access the money you put into your savings vehicle? It is after all your money, right? Err well apparently not it seems:
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So, would you prefer to be able to have penalty free access to all of it at any time you wished or would you be happy to find there was a hefty penalty for doing so? Assume for a moment you had saved for 4 years of a 20 year term and wanted your money back. According to the matrix above from the adviser copy of the plan brochure the amount of your regular contribution account value you might receive after 4 years would be 50.8% of its market value after 1% annual allowance. So that’s 50.8% of 96% of what you’d put in - less charges. Bear in mind the circa 10% in fees already lost on each contribution and the 1% annual fee on the whole too. How would you feel? Even after 10 years you’d only get back 77%. Imagine you’d saved £1000 a month for 10 years, that’s £120k and then you’d lose 23% of the total as a surrender penalty as well as having paid all the other fees. I know how I would feel and I would not be pleased. I notice that there is no mention of the actual surrender penalty charges expressed as a percentage in the actual client brochure (SK6854/29-1081/October 2009) though there is in the adviser copy (SK3468/26-1016).
According to the brochure you can access some of your cash though. This is a cumulative total of 1% pa of the bid value of your regular contributions. So yes you could access 10% of what you had accumulated penalty free after 10 years. Who’s money is this again? Excuse me while I say “Whoopeedoo!”
They do say they will give you a 0.2% pa annual loyalty bonus if you reach maturity, with a maximum value of 4% but since you have been charged a minimum of 1% pa for running the plan, plus in excess of 7% on every contribution you paid in, plus the underlying fund charges and monthly account fee I’d consider this is really only giving you back some of your own money rather than a bonus.
Also I get clients approach me all the time and saying things like “I have seen the guy from whatever company and he is offering me this pension from XYZ insurer and they are offering (say) 50% extra allocation for the initial period. Is this a good deal?” To which I have to say well look at it from the point of view that there is no encashment value to the initial units for quite some time but that extra allocation will be subject to the same charges as the rest of the plan. So assume then for a moment we are paying in £1000 a month we are getting allocation of £1500 per month but paying 7% bid/offer spread on that plus the 1% annual fee on that extra allocation as well as your own contribution per annum throughout the term, so to me it looks very much like they give you something on paper, known in the business as notional (or “actuarial”) units (clearly referred to in the paste above as “notional”), and then take what they gave you back again in charges throughout the life of the plan.
Do you see now why I said these are complicated to follow? I hope I haven’t made this “too dry” reading but hopefully now you understand why I said what I did above about anyone actually volunteering to buy one of these if they understood it properly. I believe for all of the regulation that has been imposed on this industry in recent years regulators would do better to regulate the products and not the advisers because if such products were outlawed then they couldn’t be sold. I also almost forgot to mention that the reason expats are normally offered one of these plans and not one like the below is because these plans pay lots and lots of commission, upfront and in a lump sum whereas the below charges a little bit but only as and when something is paid in and which I believe is a better incentive to someone to continue to look after and service you as a client than when someone else was paid the money years ago and is long gone.
So what can we do instead? We do need to save, right?
What we all need is a way to save and invest but we need to be able to do it in a way that it costs us as little as possible to do so and we need it to be such that if we need to stop saving that we can, and without any penalties. Also that if we want to stop adding any, either temporarily or permanently that we can leave the money there without being charged extra just because we stopped adding to it. We want to know that if we ask for our investment fund back, in whole or in part that it is available to us without any penalties and at minimum delay at any time. We want to know that if we start saving extra into it that we can stop doing so with no expectation or obligation that the extra would continue, and if we want to keep saving but save less we can do that without penalty too.
If we could do all that would it not be a lot better? Well the good news is that you can. You just need to cut out the insurance company and save directly into funds.
We can access the same type of investments at much lower cost so there is more there for the investor and we avoid the restrictions and penalties too. We cannot avoid the underlying annual management fees of the fund managers because like any company they cannot collect and administer our money, send statements and pay compliance fees and taxes, staff salaries, utilities and rents nor otherwise run their business on fresh air, but they do at least make us the profits we seek. We can however cut the 7% bid/offer spreads down to 3% and we can avoid the additional annual 1%, and we can also dispense with the monthly account fees. We can dispense with the penalties and restrictions and we can buy award winning funds. These are exactly the same sort of funds that are on the fund menu of the plan above, and in one case I regularly use exactly the same multiple award winning fund, but without all the extra charges and conditions. There are some excellent funds which are ideally suited to regular savers and which have long term track records of excellence and consistently high peer group rankings.
Most of the work I do is actually for high net worth individuals who contact me with larger lump sums to invest and we have a variety of solutions available to them, but I hate to see people waste money so for the regular pension saver I have a lot of clients from around the world who simply save regularly straight into funds and I tend to use companies who provide a manager of manager facility because this enables you as the saver to “save and forget it”. This means while you concentrate on doing your job and getting on with life that the managers have a wide mandate and are able to invest your money pretty much anywhere within reason they see opportunity and which means that instead of you worrying how the latest crisis has affected you or whether the investment theme you selected last year is still the best place to be invested, that the managers will take those decisions for you and adjust accordingly.
You don’t have to decide whether Europe or the US, equities or bonds, property or commodities etc as they will do that for you and will ensure you have a broad spread of investments. If they feel defensive then they will make the portfolio defensive, and if they feel a bit more bullish they will go for it there too. I have a variety of such funds I use and some would be more suitable for some than others but what they have in common is that they have none of the restrictions or penalties we have discussed above, for a returned UK resident can be more tax efficient as they are subject to 18% CGT after generous tax free allowances rather than income tax, and by discounting the commission I could have taken on these my own clients pay only 3% rather than the retail rate of 5%. I don’t say you have to come to my company to get into such funds but I do think you’ll see this solution as a huge improvement on the alternative above and hope by reading this I might at the very least have saved you from a possible expensive mistake.
A golden rule of my own worth remembering is “insure with an insurer but invest only and directly with a specialist investment company”. In my 30 years of experience I have learned that the two do not usually mix well.
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