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How to combine pension pots

 

Today, few of us stay in the same job from leaving school to when we retire. The result is that many people have lots of different pension pots. However, combining them could make real financial sense.

Why move your pension?

The most obvious reason for moving a pension is to get better investment performance and lower charges to boost your retirement income.

But there's a downside: you could get hit by exit penalties on your existing fund, pay over the odds for advice or be lured into a higher-charging product. And if you are close to retirement you might not have time to recoup the costs even if you do move to a better performing fund.

What have you got?

You might well have several different types of pension. The gold standard is the final-salary scheme, which pays a pension based on your salary when you leave your job and years of service.

If you have any past or current contributions in a final-salary scheme, don't move it unless (and this is very unlikely these days) you are moving to a job with another final-salary scheme with at least equal benefits. Experts say that in the vast majority of cases it is not worth consolidating your final-salary benefits.

There are concerns that employers are trying to lure customers away from generous final salary schemes in a bid to cut costs. Always seek independent financial advice before making a decision you are likely to regret.

Your past employer might try to encourage you to move your pension away by boosting your fund with an 'enhanced' transfer value and even a cash lump sum. This still may not compensate for the benefits you are giving up, and you may need an exceptionally high rate of investment return on the funds you are given to match what you would get if you stayed in the final-salary scheme.

If you are lucky enough to be currently contributing to a final-salary scheme, check whether your employer will allow past contributions from other pensions to be moved into it.

But if you've got any other kind of pension - a money purchase occupational scheme or a personal pension - you should consider bringing all your past pensions into one place. These pensions rely on contributions and investment growth to build up a fund. When you retire, this money can be used to buy an annuity which pays an annual income. With these schemes you take the risk - so if the stock market tumbles then so does your pension fund.

It can often make sense to bring these pensions under one roof as you may benefit from lower charges and you might be able to boost performance. A key advantage of moving your funds into one pension pot is the ability to monitor fund performance more easily.

One type of personal pension, known as a Sipp, will allow you to track the performance of your investments online to see if you are on course to reach your target for retirement. Consolidating your money into one pot also means you will have less paperwork gathering dust.

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Making the best of it

If you've got money in some past pension schemes, then you should aim to make it work as hard as possible. Moving to a pension that gives you higher growth could allow you to retire earlier or stick to your original retirement date but with a higher income. If at age 40 you have £30,000 sitting in an old scheme, earning 4% a year, this would give you a fund of £79,975 at age 65, which would buy a single man an annuity of £5,494 a year (May 2011). Move to a scheme paying 7% a year and your fund would grow to £162,823, giving a single man an annuity of £11,193 (May 2011).

Charging ahead

Beware. Even if your pension is performing relatively poorly, you could lose out by switching because of charges, especially if you are close to retirement. Some of the old-style pensions contracts set up in the 1980s and early 1990s have severe exit penalties of 15-20% of your fund if you switch before your stated retirement age. Firms such as Standard Life and Norwich Union scrapped exit penalties for all policies - old and new - in 2001.

Many other firms, however, still apply significant exit charges on old policies. Your contract should state whether there is an exit charge for leaving early but you should also check with your pension provider or financial adviser.

If you took out a pension policy after 2001 you won't normally have to pay an exit penalty. But if your pension is invested in a with-profits fund, then the firm may apply a withdrawal penalty - called a market value reduction (MVR). Most providers have reduced these penalties dramatically and some have removed them entirely for the time being.

If you're particularly unlucky may be hit with a double whammy of an exit penalty on your old pension contract and an MVR because it is invested in with-profits funds – all the more reason to check the terms and conditions with your provider.

But just because a pension has a high exit penalty, this doesn't necessarily mean you should stay in the fund. Some of these funds have very little money invested in , giving poor prospects of investment growth. So it might be worth taking the hit and moving to a pension with better investment performance - particularly if you have many years to go until retirement.

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Choosing a new pension

If you're bringing all of your pensions under one roof, it's a good time to look at the pension you are currently contributing to. What are its annual management charges, and will it make an initial charge on money you transfer in? Is its investment performance good enough? If the charges are high or the investment performance is not up to scratch, it could be time to move all your money to a brand-new home.

Most providers charge an annual management fee, which is a percentage of the value of your funds. If you want to take a fairly safe option, consider stakeholder products, which will only offer you a limited range of funds. These can charge a maximum of 1.5% a year but some providers charge 1% or under.

Costs vary more if you want to choose your own investment funds by using a self-invested personal pension (Sipp). Some such as Alliance Trust Select Sipp, Hargreaves Lansdown, Bestinvest, and AJ Bell's SippDeal have no set-up costs. Most of the life company funds charge a set-up fee as well as an annual management charge. From then on, costs will vary and the more you use the investment flexibility on offer, the higher your charges.

Read our guide to finding a low-cost Sipp Q&A

These costs can quickly add up. If you invest in a Sipp, make sure you are not paying higher charges for just sitting in the insurance company's own funds, which you could access more cheaply in the same firm's standard personal pension or stakeholder product.

The cost of advice

A good independent financial adviser should make you much better off in retirement by finding the best pension investments. However, if you have a small pension fund of just a few thousand pounds, the cost of paying hundreds of pounds in commission or fees to an adviser could outweigh any advantage of moving, says Donna Bradshaw from adviser IFG Group.

Advisers can get paid handsomely for recommending a certain provider's pension over another. This creates commission bias which, in turn, can lead to mis-selling - something the watchdog the Financial Services Authority is trying to crack down on.

Some providers pay up to 6% commission on Sipps - meaning advisers get £6 for every £100 you invest for the first two years - plus trail commission of up to 0.5% of the fund each year.

Sometimes, this charge will come from your investment and sometimes the provider will pick up the bill. But in either case, the amount of commission could sway the choice of plan. Good IFAs should either charge flat-rate fees or no more than 3% on regular savings. If your money is invested in a pension for a long time, high charges and commission can really deplete your funds.

If you use an adviser, it is often better to pay a fee for their advice so you know they are not being bought by commission and all the money you invest goes into your pension.

Don't switch off

Before switching your pension, bear in mind other benefits you may be giving up. It might be worth sticking if you have a guaranteed annuity rate. These guarantees are valuable because the income on offer tends to be higher than that now available.

Experts say many of these guaranteed annuity rates were set when interest rates were as high as 11%. So if you had a £10,000 fund you could receive as much as £1,100 per year with your guaranteed annuity rate against £600 in the open market.

Some policies give you life insurance which you might lose if you switch pensions. This could be crucial if you are in poor health as you will have to pay huge sums of money to get new life cover.

Updated May 2011, Dan Hyde, This is Money

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