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Profit from the pension exit fee cap

Fees for early pension exits will soon be capped at 1 per cent and switching to a cheaper scheme could save you a lot of money
February 28, 2017

Investors locked into old-style pensions with hefty exit fees will soon be able to remove money early and, at most, only pay a 1 per cent charge. The Financial Conduct Authority (FCA) is capping exit fees on personal pensions at 1 per cent from 31 March to try to help those aged over 55 to move out of old schemes, which often have high charges and little or no flexibility.

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According to the regulator, £22.5bn is invested in old-style contracts with exit penalties, and £10.6bn of this is in pensions with an exit penalty of 1 per cent or more, while £6.2bn is in pensions with an exit penalty of 2 per cent or more. These fees could wipe more than 10 per cent off the value of a pension pot, according to provider AJ Bell.

But AJ Bell also found that investors with a £100,000 pension fund could have £27,337 more in 20 years' time if they move it away from a scheme with an ongoing charge of 1.75 per cent into one with a 1 per cent charge, assuming investment growth of 5 per cent.

Over 10 years, investors with a £100,000 pension fund could save £5,484 by switching it from a scheme with a 1.5 per cent charge into one with a 1 per cent charge. Over one year the exit fee would leave you worse off than before. AJ Bell says a 1 per cent exit penalty can often be recouped after one or two years of being in a scheme with a lower charge.

Gary Smith, chartered financial planner at Tilney Group, adds that the benefits of a lower-cost scheme, which often comes with greater flexibility and a greater choice of investments, can outweigh the initial exit charge.

And Nathan Long, senior pensions analyst at Hargreaves Lansdown, says: "It makes sense to consider switching where you have an older plan with very high charges and a very limited choice of investments."

This can be done within weeks if an electronic transfer is possible. "But if you have anything that needs to be manually transferred it will take longer," adds Mr Long. "Old occupational pension schemes, for example, are likely to take longer because they might not be signed up to electronic transfers, so could take months."

The personal pension schemes most likely to have high exit fees are those taken out in the 1980s and 1990s, before the introduction of stakeholder pensions. Many of these schemes are now closed to new business. "These tend to not be offered by mainstream providers, but more likely legacy pension providers, who have since been taken over," says Mr Smith. "These companies spread the charges over the expected lifetime of the plan, which is why their penalty is higher for anyone wishing to exit early."

Meanwhile, if you want to make use of any of the options for drawing income, introduced by pension freedom legislation in April 2015, you may have to transfer into a different pension scheme. "When pension flexibility was introduced it was not compulsory for schemes to adopt the new rules so not all plans offer options such as flexible drawdown, succession drawdown, or the ability to inherit pensions or take flexible lump sum payments," says Mr Smith.

But it doesn't always make sense to move away from an old scheme, for example if it offers bonuses or high guaranteed annuity rates. "Older-style pension schemes can come with guaranteed annuity rates reaching double digits, which is very attractive when annuity rates are typically 3 or 4 per cent," explains Mr Smith.

It may also make sense to wait until you can leave the scheme without incurring an early exit fee, for example if you do not urgently need the money from your pot and your agreed retirement age is approaching anyway. Investors below age 55 who are still building up a pension, meanwhile, will not benefit from the forthcoming exit fee cap until they reach retirement age.

 

How much you could save/lose by transferring

Year1.75% charge1.5% charge1.25% charge
1-£290-£540-£790
2£473-£44-£562
3£1,291£490-£316
4£2,168£1,064-£49
5£3,107£1,680£239
10£8,855£5,484£2,040
15£16,727£10,759£4,585
20£27,337£17,942£8,106

Source: AJ Bell

Table shows how much more or less an investor would have if they switch pensions compared to staying where they are. Based on switching £100,000 from a pension with a current annual charge of 1.75 per cent, 1.5 per cent or 1.25 per cent and an exit penalty of 1 per cent, to a new pension with a lower annual charge of 1 per cent.