Penalty fees make a mockery of freedoms

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      Penalty fees make a mockery of freedoms

      They were sold to professional people such as solicitors and accountants who could not join an employer’s scheme and they were expected to remain in force for many years. Similarly individual arrangements sponsored by an employer and known as executive pension plans or individual retirement accounts, were written to ages when most people would expect to have long retired.

      Other plans were sold to workers with no employer pension by ‘industrial branches’ of the insurance company. The ‘Man from the Pru’ did a good job in spreading pensions and other savings among the less affluent, but he too had to be paid.

      As the plans were designed to run for 20 or 30 years or even longer, the salesmen had to be rewarded for the fact that once the plan had been set up most policyholders would keep paying premiums for a large part of the policy term. This led to commissions that could be as high as 150 per cent of the first year’s premium.

      In order to recoup the costs of setting up the plans the insurers designed a number of methods to do this without pushing the process to the fore of their marketing. Premiums paid in the first year – and in some cases in the second year too – were invested in ‘initial’ units or in ‘capital’ units, with subsequent premiums being invested in ‘accumulation’ units.

      While all units usually had a 5 per cent bid/offer spread, the initial or capital units were also subject to further ongoing charges. Initial units might face a 4 per cent to 6 per cent annual charge over the term of the policy, effectively clawing back the commissions paid in a way that, while not painless, was not clearly visible to the policyholder.

      The natural result of these initial unit charges was that if someone wanted to take their money out early to retire, or to transfer to another plan, the costs which had yet to be recovered had to be taken as a lump sum. A charge of 6 per cent a year for a policy with 12 years to run would incur a transfer charge of more than 50 per cent of the initial units.

      For a policy that had run for a large number of years, losing half of the first year’s contributions might not appear too bad, but of course, these were the premiums that had been invested for the longest, and therefore the penalty for taking them out was disproportionately high.

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