MTTM Podcast 88: Why you should wait to cash in your pension, Credit Card Small print & Equity Release alternative
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Do you remember back in 2015, George Osborne got everybody excited about pensions after saying that they would be able to cash in their pension, take their money, and buy a Lamborghini or whatever they want to do with it. It was meant to give you so much more flexibility in retirement.
The bad news is that whilst the idea is wonderful it doesn't always quite translate into reality when you try and put these things into practice. Pension companies are shrewd and they like to keep your money. If you remember, back in the '70s or '80s, there were pension products that were set up and they were paying salesmen hefty commissions. In order to pay for those hefty commissions, they had to have charges that went on for pretty much the life of your pension as they were slowly clawing all that back so the pension provider would make some money.
So the key was your pension pot couldn't go anywhere and the only way they could insure your pension pot couldn't go anywhere, that you couldn't transfer it to somebody else and get a better deal, was to put you in you in handcuffs by applying exit fees if you tried to cash in or you tried to move it. These exit fees were as much as 10% or 20% of the fund value which is ridiculous.
So this is going back to when I first left university, and was training to be an actuary. They used to get me in to do these complex calculations to work out how much money people were owed as a result of being mis-sold a pension. These people once had a company pension, a very nice final salary scheme, and they were convinced by a salesman to use a personal pension to transfer out and inevitably they were always worse off.
The penalties were just one of the things that we used to have to add into the calculations. So for somebody like me, I've almost become numb to the idea that there are penalties. But that's a shame, really, because that's just the way the industry has always been. As we've moved on, fortunately, the penalties have reduced, and competition and the better regulation have meant that that kind of shady practice has been reduced. But there are still penalties out there. Typically, some of the newer contracts might have a few percent you're going to lose off your pension fund.
The problem is, there were a lot of people who got excited about the pension freedoms when George Osborne announced them, and decided, "Yes, I'm going to cash in my pension to do some amazing things," only to be told by the pension provider that, "Yes, you can do that, but there'll be a 20% charge."
Now what's happened is the FCA, the regulator, has now come along, looked at this in their wisdom and decided that from March 2017, all existing pension plans are going to have an exit charge capped at one percent.
Now that is good news. So if you've got a pension, you're trying to encash, or you know somebody who is looking to do that, so it could be a parent, grandparent, then it may be they need to check those exit penalties, and if they're more than one percent, then they may want to hold off, because March 2017 is a key date. This affects a lot of people. 670,000 people would pay as much as 10% exit fees on a pension.
The other bit of good news is after March 2017, all new pension schemes cannot have an exit fee. There will be none. So they will be gone. So pensions are becoming more attractive in that way. The handcuffs are coming off of pensions, so we should be all getting more of those pension freedoms.
I have to caveat that a bit, because I'm not convinced that the pension freedoms as they exist now will exist when you and I are 55. I mean, the retirement ages are going to go up, but I just don't see that they will stay in their current generous state. That you can just cash in your pension pot, because at some point, I'm sure the government or future government will decide that everyone's running out of money or people aren't saving enough, and the state can't afford to keep them all. That's just my opinion. But it's good news for anybody who's got a pension or might want to cash in their pension soon.
This is where my moan comes in, because what I don't understand is why they didn't ban exit fees completely on the existing pension pots. Now I know that would spell big trouble for some of these pension providers, because they've embedded these 10% exit penalties. They've had clever actuaries sitting in some dark room somewhere in head office 20, 30 years ago who worked out how this thing would make profit, but I think they should have banned it altogether.
The other thing to add to this is that occupational schemes aren't part of this at the moment, so they're doing another consultation on occupational schemes. What's going to happen to their exit charges? Listen out for that. My moan is why wasn't it banned completely for existing people? I don't understand that. That just seems to me to be a copout.
Another point is that a lot of these companies still have exit penalties on other products, like ISAs. So, for example, you might want to move your ISA to somebody else, and they will charge you £25 per line of stock. Let's say you had 10 funds in an ISA portfolio that would cost you £250 to move. Now I think that is something that shouldn't occur in the industry. There are some platforms that have actually started to drop their exit penalties, but I don't see why there should be any exit penalties at all on any of these products, and they should be banned.
So that's my rant, that's if the FCA ever listen to this podcast, then that's what I want. The tip there is you can get round some of those charges, because they actually do it per fund, so if you transfer all the funds into one fund just before you move, then you only pay one £25. So there you go, there's one way around it. But, you are slightly out of the market at that point.
Now, there was a story, which I won't dwell on, where they were saying that we should have 7 switching on mortgages. And the reason they want this is that they want more competition in the mortgage market and they want to encourage people to shop around. The reality is, the reason why they want people to be able to switch in seven days is they want people to start moving more and more to fixed deals, because the Bank of England don't like the fact that most people don't switch mortgages, because 70% of the people are on a variable rate mortgage. If they put interest rates up, suddenly, we all become that bit poorer.
One other thing, we already have 7 day switching on bank accounts to encourage more competition and there was news the other day that there was a call recently for 7 day switching to be extended to mortgages. So why not a 7 day deadline for pension withdrawals?
Just a thought, because if you've ever tried to transfer a pension, it is a nightmare. The pension companies just drag their heels because they want to keep your money. The longer they keep your pension pot, the more money they make, they don't want you to give it away.
So great news on these new exit penalty caps, and allowing people more pension freedoms, but let's just try and go a little bit further, and actually do more to encourage people to engage with investing and pensions generally, by having some of these other things looked at as well. Rather than just wait until you're driven to do something by George Osborne just because he's got a political will to make something work.
Credit card small print
This next piece is something that, again, I think needs to be looked into, but it's a really important one to do with credit cards that a lot of people will be caught out on. There will be people listening to this podcast who probably don't even realize that they are being caught out on it.
I am talking here about money transfers. Now, we all know about balance transfers. We love them. 0% balance transfers are a great way to clear debt. We've covered it in podcasts before. If you've got large credit card bills rather than pay 18% a year in interest, you could move it to a 0% card and pay a minimal couple of percent transfer fee, so it makes sense. You can pay your debt off quicker. Now, there are some great deals out there for 36 months at 0% and there’s one that's almost four years.
However, there is a feature on these cards called money transfers. Where you can have some money transferred into your bank at a rate of 0%, which obviously, sounds a great deal. It's one of those things that is attractive and it's pushed by the likes of Money Supermarket to help people who need a short-term loan, put it this way, it is far better than a payday loan.
The problem is, that there's a slight catch to this that people might not realise. Years ago, there were rules in place whereby if you had differing rates on the credit card for different types of transactions, let's say, you went and spent money on a 0% balance transfer card. Then the money you were spending, that wasn't part of your original balance transfer, would still get the 18% rate.
So you might think, "Oh, I'll clear my bill at the end of the month." Then even if you did do that, the credit card company, very sneakily, would take that money and actually clear some of your 0% balance, rather than the bit that you'd just spent at the shops and you're going to get charged 18%.
So you could be sitting there thinking you're clearing your balance every month, but actually, they're just chipping away at the bit that they're not making any money on, and leave a growing bill that you're spending that's being charged 18%. However a change in legislation that stopped them doing that. So they had to apply the repayments to the highest interest rate, which seems the right thing to do. However, with regards to these money transfers, they're very shrewd, they will do the money transfers at a different term to the balance transfer.
When I say "term," I mean the length of time, so they might give you a balance transfer of 0% for 36 months, but they might give you a money transfer term for, let's say,12 months, and that will be at 0%. So let's just say you decided to get £2,000 on the money transfer, because you needed that for a short period of time, and then almost immediately you paid back that £2000, and you think, "Do you know what? I did it in the right period of time with that money transfer deal and it's all cleared." But because they both actually have the same rate of interest, i.e 0% the credit card company can still apply it to your balance transfer.
So what they all do is after the 12 months, your money transfer will still show you've got £2,000 outstanding, because at that point, it will tick off the 0% and go onto whatever, 18%, 19%, and suddenly, you've got a couple of grand of your bill that's getting charged that higher rate.
The thing is, people just look at the headline rate. I mean, why wouldn't you? You just look at your overall bill and you're thinking, "This is all at 0%." So I think it's, again, something that's unethical, something that needs to be looked at and changed, The reason I mention it is because its one of those things that we would all get caught out by, everybody would, because you just wouldn't look at that small print, and we all think that the rules have been changed. So it's one to look out for.
An alternative to equity release
This story is particularly relevant, because as a population, the world is getting older, there are more and more people who find themselves in the position whereby they maybe have passed the state retirement age and still want to borrow money against their house. Because let's be honest, for most people, their house is their biggest asset and given how much house prices have rocketed, then you can see why they want to borrow money.
Now, do you remember there was a mortgage market review recently, there were rules that came in about affordability? Previously, lenders used to be very free and easy with their lending back before the credit crunch. Now they actually have to make sure that people can afford the mortgages that they're lending to them, so they have stricter affordability tests.
The downside of that is that certain groups of people got pushed out of the market because lenders didn't really want to get involved, and one of those groups is people who are older. For example people who may want to borrow money beyond the age of 65. Let's be honest, most of us would hope we'd cleared our mortgage by the time we retired, but the reality is, that a lot of people won't have, or they might want to extend their house, or borrow money for whatever reason.
Now, the strange thing is, there were a lot of people who are retired who can afford to repay a mortgage. So if they could get a mortgage, they could actually afford to keep up with the repayments, because they might have decent pensions, or investments and stuff like that. So now what would normally happen is they would veer down the equity release route. We've done a whole podcast on equity release. So go back and listen to it if you want to know more. But effectively, equity release will release some money from their house while they can still live in it. One of the most common equity release products is where people take out a sum of money, so they release some equity and it's rolled up with interest, and basically, it comes out of their estate when they die, and it means that when they want to pass on their house, for example, to their children there's less of it. A lot of people are put off by this, because they don't want to be losing the equity in their house to a lender. And these equity release schemes are expensive compared to a standard mortgage.
So you can see why if you're 65-plus, you might be looking at it and thinking, "Do you know what? I don't really want to get into equity release." Not that it's a terrible product, in the right scenario, it's okay, but you may think, It's expensive, and you are not really that comfortable with possibly giving away a portion of your house, that is your children's inheritance, especially if you can actually afford to keep up with payments if you have a normal mortgage.
There are now some solutions, and this is relevant for people over the age of 65. Don't switch off just because you might not be over 65. Chances are, you know somebody who is over 65 and if it's a parent, grandparent, and this could impact your inheritance. I just want to run through the other options now open to people. The positive that's happened in the industry in recent months, is some of the lenders have started to increase the maximum age at which they will lend to people. This is the maximum age to which an existing mortgage can run. It is now possible for people to remortgage now if they're over 65. You have to shop around if you want to be able to find somebody, if you want to keep the equity in your house and actually remortgage.
The problem is that because they all probably want to borrow for a short period of time, and probably a relatively small amount, a mortgage can make it expensive. This is because a mortgage that's a low amount and for a short term, could have upfront costs of setting up that could potentially make it prohibitive. So it isn't always a nirvana of being able to get a mortgage. The only other thing I would say is if you start to explore the idea of remortgaging is look at the penalties of your existing mortgage.
The other option that people have is that they might be able to take an advance from their existing lender, so they might actually get to borrow some more money from them, but that will probably be on a different rate, and naturally, a higher rate than the amount they've actually got in their current mortgage. So that's an option. So don't always just assume equity release is the only thing you can do, just because you're bombarded by adverts and stuff you see in the press.
The third option is you can actually place a second charge against the property from another lender. So, you take out another mortgage, effectively, another loan against the property, but it will likely be, again, at a much higher rate. So there you go, that was just a roundup for people. There are more options than equity release.
If you're going to have advice on those things, you need to shop around, and you can get mortgage brokers who are worth their fee that can arrange you a really good deal. So, if there's anybody who you know who falls into that elderly category, then there is hope and other options.
When you're ever looking or reading stuff about investment, always ask yourself the question, "Does the person have any skin in the game?" And if they don't, then I would argue to take their views with a pinch of salt, because there's loads of talking heads out there, and some people argue that I am a talking head. You know, where you get an investment piece or something in the paper, and a journalist will ask you your opinion.
But for a lot of those people, their job is to talk about investing, or funds, or something like that, but there's no comeback for what they do. They’re just venturing an opinion, and if their opinion is right or wrong, there is no comeback. Now, the difference is that people might sit there and say, "Well what's your skin in the game?" And obviously, for me, it's the 50 grand portfolio I run on 80-20 Investor. And I tell you what, it makes a massive difference if you’re putting your money where your mouth is.
It’s very easy to pick your winners, isn't it? When some people gamble all the time, they turn around and tell you about how wonderful they've been, but they don't tell you about all their losing horses. Now it's very hard to do that when you're doing things in public and saying, "Look, here's my portfolio, here's when I make fund switches,”. So yes, it's just a general tip. Ask yourself "Are they backing their convictions? Do they invest their money how they're trying to tell everybody else how to?"
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