Welcome to session number 78 , and we’re going to be talking about Protecting Your Pension. This session was inspired by regular listener and correspondent Miss MoneyPocket, listening over there in Valencia, Spain. She left me a voicemail last week, which I’ll play in a minute, and she got me thinking that there must be lots of other people concerned about the protections offered and risks surrounding pensions and other long-term investments. Lots more on that very shortly….

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Introduction

I’ve spent a bit of time recently talking about retirement and the provision for it. Last week we looked at the ten years out position, and back in Sessions 72 and 73 I covered off how to retire early. Can you imagine having saved carefully for years only to have something go catastrophically wrong and lose some or all of your money?

Thankfully this is extremely rare, but a very high-profile recent-ish example is that of Equitable Life. Equitable were the first mutual insurer in the world, founded in 1762, and built a fantastic reputation in the UK as being a top-quality company; a safe pair of hands. Thing is, they had several million policyholders who enjoyed very attractive guaranteed benefits on their pensions with Equitable.

Usually, insurance companies take care to hedge or reinsure liabilities like these, so they can always be sure they are covered. Equitable chose instead to rely on their ability to restate bonuses on these policies. Problem was, this was challenged in court when they actually did apply it and Equitable lost that case.

This meant that they immediately had to find the money for an added £1.5Billion of liabilities, which meant they had to sell. No-one was buying. The company immediately closed to new business and everything went south pretty quickly.

The UK government has stepped in to some degree, but many Equitable Policyholders are only receiving just over a fifth of the value of their policy and they are waiting many years for the money.

Miss MoneyPocket’s voicemail refers to Equitable Life and she asks how we might protect our pensions going forward from events like that.

Everything you need to KNOW

As usual, before we get practical, we need to set the stage for that by looking at what you need to know. Are you ready? Lets go:

1 – Episodes like Equitable Life are (mercifully) very rare

There have been very few cases such as Equitable Life, where a financial services provider has got things so catastrophically wrong. But the financial crisis of 2007-2009 and beyond has shown up some serious weaknesses in the financial system. Even the brightest minds were slow to pick up on these failings, and no-one was able to stop them from nearly destroying the economic system as we know it.

The three biggest Icelandic banks were essentially shut down in 2008. Massive American state-sponsored institutions like Fannie Mae and Freddie Mac were bailed out at a cost of hundreds of billions. Northern Rock, Bradford & Bingley and others were previously leading lights in the UK mortgage market, but which were brought to ruin due to unwise lending practices. Even the biggest life insurance company in the world, AIG had to be bailed out and has now been broken up and many of its constituent parts sold off.

We are mercifully out the other side of the financial crisis and great recession of the early 21^st Century, and hopefully some lessons have been learned, though I doubt it. As the financial and economic worlds get ever more complex, regulation needs to catch up, something which so far it has failed to do.

Having said all that, there are far more healthy institutions than unhealthy ones.

2 – There are many different kinds of risks to protect against, most of which are much more likely to happen than another Equitable Life

The failure of a financial institution then is a rare event. There certainly was a flurry of them back in 2008-2009, but those were once-in-three-generations events (we hope). There are risks to your pensions and investments which are far more likely to have an impact than provider failure:

• Markets may fall and your pension value could be affected
• You may make dumb investing decisions, with the same effect
• The charges you are paying could decimate the returns you achieve
• Your provider may become a zombie provider and your pension could become a walking dead policy
• You may neglect your policies and sleepwalk into a bad outcome

I see clients every week that have pension plans that fall into one or more of these categories. Whereas I have only ever had one client who had experience of provider failure (not based on my advice, I hasten to add!).

These are the risks which need to be mitigated first and foremost, of which more later

3 – There are mechanisms in place which are there to protect your pension if something goes badly wrong

The first line of defence is common sense, as it is in so much of life. But there are scenarios where no matter how careful you are, something out of your control goes wrong, such as a provider failure. For this, the Financial Services Compensation Scheme (FSCS) is there to protect your interests

The FSCS is government backed and there are very clear limits to its cover and protection. It is there to step in if a provider cannot meet its liabilities, which simply means if it goes bust. Here are the limits:

• Savings on deposit: £85,000 per person per banking institution
• Other investments: £50,000 per person per institution
• Pensions and life assurance: 90% of the claim, with no upper limit

It is best to stay within these limits if at all possible, in order to be sure of being covered by the scheme. This is fine for most people, as most people simply won’t amass enough money to ever have to worry about having more than the FSCS limit with one bank, say. But many people do get to that level and so it makes sense to have a mind to these limits as you plan your portfolio.

More detail on this to come too…

4 – Many risks are ultimately out of your control – make your peace with it!

Worries about the future, particularly our financial future, lead many of us to lose sleep at night. I have always said that it makes no sense to lose sleep over things you cannot control, and many risks to pensions, investments and the like are outside your control. Easy to say, I know, but do try and get things into perspective when you are thinking about this stuff and try to relax about the stuff you have no influence over, concentrating instead on the things you CAN do…

Summarise KNOW

#1 – Episodes like Equitable Life are (mercifully)very rare

#2 – There are many different kinds of risks to protect against, most of which are much more likely to happen than another Equitable Life

#3 – There are mechanisms in place which are there to protect your pension if something goes badly wrong

#4 – Many risks are ultimately out of your control – make your peace with it!

That last one is true, or else I wouldn’t have said it! But even though you can’t control the factors that lead to the various kinds of risks to your pensions, you can limit the effect of them by taking some fairly common sense steps. Let’s look at those now…

Everything you need to DO

So let's deal with everything you need to DO to protect your pensions and investments

1 – If possible, diversify

Whoa. Hold the phone. Last week – only last week – I said that with ten years to go until retirement, you may want to consider rationalising your pension provision and maybe merging several pension funds into one. Was I full of it, or am I just changing my mind?

Well, bear with me. There are different levels of diversification to consider here.

First up is provider diversification. It is clear that having everything with one provider might seem like having all your eggs in one basket, and a risky move. What if that one provider went the same way as Equitable Life? Fair point, though you need to get to know your policies (more in a minute) to determine if this is a risk worth taking.

Next is wrapper diversification. I’m a big fan of having multiple tax wrappers as part of a balanced portfolio. No sense in having everything in pensions and not using up ISA allowances, or even, if the money is there, Venture Capital Trusts. Having multiple tax wrappers in place brings choice and financial planning flexibility when it comes to deriving an income from your portfolio, or gifting assets to children.

Finally, you have investment diversification, which is what most of us tend to think of when using the word diversification. Spreading the money around different asset classes such as shares, bonds, property etc and across different geographical areas of the world will reduce the risk of something going badly wrong.

Utilising some or all of these will reduce the impact of a seismic event with either a provider going belly-up, a tax angle being withdrawn or an asset class having a bad week, or year, or three.

2 – Get to know your policies

It used to be the case that you got a pension from a life insurer, and you got an ISA from an investment house. They were basically the two forms of provider that existed. Most of the problems of the past have been down to life insurance companies being very opaque institutions with hidden inner workings built up over centuries.

Investment houses are simpler beasts, and there are clear rules about the segregation of client monies from the assets of the company, so if an investment house gets into trouble, they can’t lift some money from your ISA to smooth the way.

Transparency is the name of the game now, and this is why I am less concerned about provider diversification than I might otherwise be. I’m also encouraged by the increasing specialism being displayed in the financial services industry.

By that I mean that there are companies now who do one thing and do it really well. These are SIPP providers, and investment platforms, investment houses that just run money and do it well.

It is definitely worth taking the time to get to know the providers of your pensions and investments and how it all fits together. Whereas before you had a pension with a life insurer and invested in their With Profits fund, now you might have a SIPP with one company. Inside that you might have a platform account with another company and a slew of investments each managed by different providers again. In all you might have 20 different providers working at some level of your pension.

This sounds more complex, and I suppose it is on paper, but while you might only have one pension, within it are different levels of diversification.

I tend to recommend that people begin saving into a pension using a Stakeholder pension provided by a life insurance company.That is because these plans are cheap, simple and flexible. Once a client has a reasonable amount of money in there, I would normally suggest that they switch to a SIPP or SIPP-like pension on a platform and spread the money around various underlying investments. This arrangement is flexible and infinitely scalable to take into account different investment choices and retirement options which are often more limited with insurance company pension plans.

Get to know your plans. Are you limiting your options and increasing your risk of over dependence on one provider? If you have multiple plans and are considering tidying them up into one plan like I suggested last week, you might want to  consider doing so into a SIPP arrangement – just watch the costs.

3 – Keep to the FSCS limits where possible

I mentioned the FSCS limits earlier. As a general rule it makes sense to stick within these limits. So I wouldn’t recommend having more than £85,000 with any one bank for example, or £190,000 if you are a couple. There’s just no need to with so many banks available.

With investments there is a great deal of choice too. This time the limit if £50,000 per person, but I would be less uptight about going over this, because investment houses have to segregate their clients’ money from their own money as mentioned above. Plus, if an investment house is further subdividing your money across fifty-odd different holdings, then this helps further spread the money around.

With pensions and life insurance, the FSCS cover is 90% of the total claim, with no upper limit. You need to be very careful here, particularly if you have SIPP arrangements or other platform accounts, because who needs to go bust in order for you to have a claim?

A SIPP company is really just an administrator; they don’t hold your money, for the most part. They just make sure you are sticking to the rules and they claim tax relief for you, things like that. If they went bust, your money is held elsewhere, so you would just bring on another SIPP provider. If you hold a platform within a SIPP, well they don’t really hold the money either, they just give instructions to deal on it. The money is likely held with a third party nominee, so your real issue is if they go bust!

So it isn’t as straightforward as it first sounds, but I wouldn’t lose any sleep over this. Try to apply common sense and as your portfolio grows, look to use the more modern ways of investing using platforms and wrappers, rather than the traditional life insurance company route.

If you’re really uptight about all this, then stick within the FSCS limits and you’ll be fine. The richer you are, the more this is a problem. Can you imagine trying to spread £5million across banking institutions while sticking user the £85,000 limit?!

4 – Pick your risks

You can’t do much about company failures, so don’t lose sleep over these. Use common sense, as I just said, but don’t lie awake at night worrying if your particular pension provider is in trouble. You can’t do anything about this so focus your energy elsewhere.

You can limit the effect of a provider going under by sticking to the FSCS limits and spreading your money around, but you also run the risk of diluting your provision, and maybe even losing track of something along the way. You’d be amazed at the people I have met who have forgotten that they have a £50,000 pension fund kicking around! By worrying too much about provider failure, you might lose sight of those things you can do something about, which are the same ones I always bang on about here on the podcast:

• Keep your costs down
• Spread your money around multiple asset classes and geographical areas.
• Invest in planning
• Enjoy your money

These are a far better focus for your mental energy because they are things you can control. So choose these areas to focus on and reduce the risks of something going wrong here.

Summary

When writing this I wanted to maintain a balance between real-life concern over pension safety and practical understanding of the issues, while trying to reassure listeners that I am not concerned about provider failure these days. I hope never to be proven wrong, but I am convinced that the market is better set up these days with better segregation of clients assets from provider capital. I hope that comes across, but the only way to be sure of never falling foul of a provider failure is to keep within the FSCS limits.

As ever, do let me know if you have any questions or comments by leaving them at the show notes for this week’s session: meaningfulmoney.tv/session78

This week’s reviews

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If you like what you hear on this podcast, please leave a rating or review on iTunes by going to meaningfulmoney.tv/iTunes just like KDK21 and MissMoneyPocket this last week. This helps others to hear about the show and to subscribe, because it keeps me near the top of the rankings.

News

Down another pound to 16 stone. Painfully slow but in the right direction. Need to pick up the pace really.

Next Session Announcement

Next time we'll be talking about Financial Forecasting with my friend Andy Hart. An integral part of any financial planning process is to project forward your financial situation and model the effect of different growth rates and different scenarios. Some advisers call this cash-flow modelling – you may have heard me mention that here before – but I’m doing to prefer the term financial forecasting. I know form experience that this part of the financial planning process is what gets my clients seriously excited because it is the first time they have ever ‘seen’ their finances in visual form.

Andy is a leading expert in this field and trains financial planners in a particular piece of software called Voyant. He has some great things to say about this subject, so if you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/askpete

Outro

That's it for this session of the MM podcast, I hope it was helpful. Again, if you have any questions or comments, please leave them comments section below

I hope you enjoyed this session. Thanks for listening – I'll talk to you next time.