Tax relief masks dire pension returns
Kathryn Cooper
ONE in four pension funds has lost money over the past 10 years. Their performance is rescued only by the tax relief on investors' contributions.
Ros Altmann, an independent pensions consultant, said: "Financial-services firms have been supported by an enormous subsidy from the taxpayer and it has taken away the incentive for fund managers to address their poor performance. The fact that we are paying high charges for low returns has been hidden by the tax relief."
A quarter of the typical pension funds run by life insurers are worth less than the amount paid in over the past 10 years, assuming a contribution of £100 a month or £12,000 in total, according to a survey by Moneyfacts, a data firm.
However, the government boosts every 78p you pay into a pension to £1. Higher-rate payers can claim a further 18p via their tax return. So investors would have paid just £78 a month for every £100 contribution to their pension fund, or £9,360 over 10 years.
Even if your fund has lost money, the tax relief can put you in profit. For example, the worst-performing fund in the survey, Britannic Assurance's balanced-managed scheme, is worth just £11,472 after charges - 4% less than the £12,000 invested. However, the fund is worth 23% more than your net contribution of £9,360.
Tom McPhail of Hargreaves Lansdown, an independent financial adviser, said: "At first glance, investors might think they have done well out of their pensions, based on their own contributions. But returns are flattered by the tax relief. Since the late 1980s, many life companies have got away with foisting second-rate funds, with high charges and poor management, on to unsuspecting investors."
The average balanced scheme in the survey is worth £12,542 - a return of just 4.5% on £12,000. But the return on your net contribution is 34%.
If you had put the same amount in the average instant-access savings account, you would now have £15,925 before tax, according to Halifax - 33% more than the total contribution. After basic-rate tax, the savings account would be worth £14,929, a return of 24%.
Over the same period, the FTSE All-Share index has risen 50%.
Justin Modray of Bestinvest, another adviser, said: "You might expect pension-fund returns to be negative over five years, reflecting market falls over that period. But it is shocking that some funds have lost money over 10 years, when the market is up by 50%."
Another £168 billion is invested in with-profits funds, which have fared better than balanced funds over 10 years because returns are "smoothed" - insurers hold back some profits in good years so they can pay out when markets are tough.
However, with-profits funds have barely beaten the after-tax returns from cash. If you had invested £100 a month in the average with-profits fund over the past decade, you would now have £15,016, according to Moneyfacts - a return of 25% on £12,000.
A year ago, someone investing the same amount would have had a fund worth £15,954 - nearly 6% more.
Richard Eagling of Moneyfacts said: "With-profits firms have been forced to use recent stock-market gains to replenish their reserves, so returns have continued to fall."
Experts are urging pension savers to review their funds and switch if necessary.
McPhail said: "The cost of sticking with a poor fund, in terms of the impact on your retirement income, is huge. It is not complicated to move a pension fund - no more so than changing your car insurance."
However, many pension firms levy an exit penalty if you switch to another company. If you took out the average balanced pension fund 10 years ago and wanted to move to another company, the "transfer value" of your fund would be £11,502, compared with an actual value of £12,542, according to Moneyfacts. Therefore the firm is in effect charging you 8% to transfer your cash.
If you have the average with-profits fund, the transfer value would be £14,033 after 10 years, 7% less than the actual value of £15,016.
Experts therefore suggest that you check if your existing pension firm has some decent alternative funds before switching to another company.
Some advisers recommend that you take out a self-invested personal pension to get access to the top fund managers.
Copyright 2004 Times Newspapers Ltd.
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