The success of a stakeholder plan depends on the return of underlying funds and provider longevity, says Ceri Jones
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For employers, the problem with stakeholder pensions is that there is little to differentiate between one provider and another. This is a consequence of the legislative framework which was designed to ensure stakeholder plans are straightforward low-cost, vanilla products.
For the provider, the problem has always been that commission on stakeholder policies is so small that independent financial advisers (IFAs) are not falling over themselves to sell them. Stakeholder pensions are a starting point for employees looking to take care of their future without much hassle or cost, but it is not a market that advisers covet. IFA firm BestInvest, for example, generally restricts stakeholder business to clients that are professional firms, where partners are likely to require additional investment products.
Paul Hoban, pensions director at BestInvest, explains: "Often, at work advice is required, which may be seminars or individual client meetings, and this is difficult under stakeholder cost constraints. In our view, the government concentrated too much on keeping down costs. One determining factor has been the underlying fund performance, which can vary a great deal."
He would prefer to migrate clients to group personal arrangements where a wider range of better funds are generally available under a slightly higher charging structure.
Certainly, the financial reality is that the success or otherwise of a scheme depends not so much on the level of charges, which are all low at 1%-1.5% or less, but the performance of the underlying funds where the difference between the best and worst fund on the market is huge. The compounding of another 1% in annual charges over the years is nothing compared with the impact of performance.
Fidelity’s Special Situations Fund is an example of a product that has soared nearly 400% over the past 10 years, compared with around 120% for the FTSE All-Share index and 110% for the typical money purchase pension scheme. Even at the fund’s normal charging rate of 3.5% initial and 1.5% annual, the additional performance clearly outweighs the extra cost over a stakeholder fund, and most discount brokers would anyway reduce the initial charge to 0.75%.
Most stakeholder providers, successful in attracting business this year, such as Scottish Widows, Legal & General, Axa and Scottish Equitable, offer a wide range of funds. Where only a limited range of tracker funds is available employees lack sufficient choice to switch to another fund if their initial selection performs poorly.
Legal & General, one of the top providers, offers 48 fund links. Andy Agar, head of retirement product development, says that 50%-55% of investors choose the lifestyle UK equity index fund. "It is a way of making contributions work harder," he says.
Scottish Equitable offers 39 funds and Axa offers 34 funds, of which 7 are tracker types managed by Hermes, while Clerical Medical offers 31. Scottish Widows offers around 20 partnership funds, and has won praise because 30% of a member’s pot can be invested in the funds of three external fund managers at no extra cost.
As stakeholder arrangements are frequently sold without advice, transparency and a top-notch customer service are important features to look for. However, excellent customer service can be elusive, owing to the product’s slim margins. Service is one of those areas where when all goes well no one pays much attention to it, but sloppy administration, such as retirement benefits or death benefits not being paid on time, is noticeable, creating ill feeling and wasting resources.
Another issue in selection will be choosing a financially strong provider that will stay the distance. Pensions, after all, are long-term plans which, under future working life patterns, may not be commuted into an annuity until 40 or 50 years in the future.
"A number of providers have not been as successful as they thought they might be. The big names are all still there such as Standard Life, Norwich Union, Scottish Equitable, Clerical Medical and Friends Provident, a hardcore of 30-40 providers, but some have left the market," says Agar.
Threadneedle Investments bucked the trend by launching a stakeholder plan last November, saying that over the past year it had found an increasing number of clients shying away from trust-based DC schemes because the responsibilities of pensions trustees are becoming more onerous and the possible liabilities more concerning.
The increase in the cap on annual management charges to 1.5% a year for a plan’s first 10 years may also reinvigorate the market and allow providers to open up their fund ranges. However, after the first ten years the cap will revert to 1% a year, and it remains at 1% for plans set up before April 2005.
Another welcome development would be if the new blanket 25% tax-free cash rule applied to an entire stakeholder fund, including from A-Day any contracted-out protected rights element, in line with other schemes under the new simplification regime. However, speculation on this point may be wishful thinking, according to Chris Bellers, pensions technical manager at Friends Provident.
The Facts
What are stakeholder pensions?
Stakeholder pensions are a type of low charged DC scheme. These are based on contracts between the individual and provider so there is no real need for trustees. As well as the cap on charges, stakeholder plans must accept a minimum contribution of just £20. Employees can stop, start, raise or lower their contributions in a stakeholder arrangement without penalty.
What are the origins of the product?
Stakeholder pensions were introduced in April 2001 to encourage those on low incomes to make provisions for retirement, with the aim of offering a cheap, flexible solution.
Where can employers get more information and advice?
The Pensions Advisory Service runs a stakeholder telephone helpline on 0845 6012923. The Pension Service (www.thepensionservice.gov.uk) on 0845 6060265 publishes a leaflet Stakeholder pensions – a guide for employers. The Inland Revenue helpline is 08457 143 143.
In Practice
What is the annual spend on the product?
Data from the Association of British Insurers reveals that employer-sponsored stakeholder premiums were £467m in 2002, £377.8m in 2003, £420m in 2004, and £371.4m in 2005. However, stakeholder premiums should not generally be taken at face value as a significant proportion is not actually new money but has been transferred from other schemes.
Which providers have the biggest market share?
Only 46 of the personal pension providers offer stakeholder products. Providers in the corporate field include Winterthur, Friends Provident, Royal & SunAlliance, Scottish Equitable, Prudential and Standard Life. But not all providers are actively seeking business.
Which providers increased their market share the most over the past year?
Industry figures are not readily available
Nitty Gritty
What are the costs involved?
Last year, the maximum permitted charge for stakeholder pensions rose to 1.5% of a fund for the first 10 years of a new contract. After the first ten years this will revert to 1% a year, and it remains at 1% for plans set up before April 2005. The cost of advice, meanwhile, will vary.
What are the legal implications?
Employers are obliged to offer a stakeholder plan if they employ five or more staff. Exemptions apply for employers offering occupational pension schemes or contributions of 3% or more into personal pensions for all staff aged 18 or over. Firms that flout the rules risk a fine of up to £50,000. Employers need not contribute, or pay for the provision of any advice. But having chosen a provider, employers must set up a payroll deduction facility for contributors. Following the mandatory introduction of lifestyling default funds last year, schemes must notify by all existing members for whom this is a new feature by April 2007.
What are the tax issues?
Employer and employee contributions qualify for tax relief. From April 2006, contributions will no longer be restricted to the age-related limits or to the earnings cap. Members will get tax relief on contributions up to 100% of their earnings (or £3,600, if greater) as long as this does not exceed the annual allowance (£215,000 for the tax year 2006/07).