Proposals to cap the exit penalties facing people wanting access to their pension pots could prove complicated and may even backfire on savers, experts say.
The government has asked the Financial Conduct Authority (FCA) to introduce a cap on early exit charges in a bid to address concerns that high charges are preventing people from taking advantage of the so-called pension freedoms.
The request, announced in the House of Commons this week, pre-empted the outcome of a consultation launched last summer on pension transfers and exit charges, in which a cap was one of three options put forward.
But the government has been warned that the move may face legal barriers, while pension experts say firms could recoup lost revenues by raising other fees.
More than eight in ten people can access their pensions without penalty, according to research by the FCA. But where charges do exist they can be punishing. Around 4,000 people aged 55 or over face exit penalties of more than 40 per cent of the value of their fund, the FCA found, with a further 17,000 charged between 20 and 40 per cent of their fund value.
The FCA is to consult on the level of the restriction, which is expected to apply to pension funds in both occupational (trust-based) and personal (contract-based) pension schemes. However it may not apply to with-profits pensions, still held by large numbers of pension investors.
“A cap will remove an important barrier for some people wanting to access their pension funds,” said Rachel Vahey, an independent pensions consultant. “It’s likely to be set at around 5 per cent, which will ensure the most toxic of penalties can be avoided.”
There may be legal hurdles to overcome first, however. Exit fees are written into contracts with the aim of recouping costs in the event of policyholders leaving before the term ends, meaning that any cap would presumably need to override or circumvent those contracts.
It may also result in pension firms hiking costs elsewhere, suggested Graeme Mitchell, manager director of Galashiels-based Lowland Financial Planning.
“For once I have sympathy for the firms. Those were the terms at the time – so why should they have to change them retrospectively? Any enforced waiver of exit fees would probably see insurers giving with one hand and finding ways to take back with the other,” he said.
Vahey offered a similar note of caution. Pension firms and trustees will have costed their plans on the basis of exit penalties applying, she pointed out.
“It could be that in order to make adjustments for this lost revenue, providers and trustees have to reduce the service they offer to those members who stay, and who don’t access their funds early,” she said.
But it’s likely to be a couple of years before any cap is in place. So what should savers do in the meantime to avoid hefty exit penalties?
Exit charges lie mainly in old-style ‘legacy’ pensions, typically taken out before charges were driven down by the 2001 introduction of stakeholder pensions.
“None of the plans I have recommended since 2000 will have any exit penalties today – modern (ie pension arrangements do not penalise people.”
Exit fees take several forms and can be levied for withdrawing money, transferring or changing the contract.
The challenge is often understanding what penalties could hit you with if you try to transfer out. For instance, many old contracts contain initial units (an extra charge built in to cover commission payments) that are clawed back through exit penalties. However they’re unlikely to be included in the transfer value given.
“If you exit before the selected retirement date (i.e. 65) a penalty applies, but if you leave the money invested extra charges are deducted every year up to 65,” Mitchell explained.
The cost of early exit will often be offset if you transfer into a more modern pension with lower charges.
“If most fees are under 5 per cent, as we’re told, it may be worth accepting the charge in order to access the money anyway, such as to repay debt such as credit cards with interest of 20 per cent a year, or in the hope of better investment returns,” said Mitchell.
But if you’re close to retirement and have a pre-2001 pension plan you should check with your pension firm how soon you can leave without penalty. This will usually be the maturity date, likely to be the nominal retirement date you selected at the outset.
Some pensions feature promises that make them worth hanging onto, most notably guaranteed annuity incomes far more valuable than any that can be bought today.
Feature such as exit penalties can make accessing or transferring a pension a messy and complicated business, so it’s worth seeking professional, independent advice.