Beware: they may look friendly but...

Pension investors could lose hundreds of pounds by investing in so-called 'stakeholder-friendly' schemes before the launch of the new pension scheme in April.

The stakeholder pension is a new low-cost scheme designed to encourage people earning between £9,500 and £21,600 to save for their retirement, although those earning more will also benefit. The new scheme will be introduced in 10 months, but several pensions companies are marketing their current personal pension schemes as stakeholder-friendly or stakeholder-compliant by offering to switch policyholders from their personal pension to their stakeholder scheme free of charge.

However, a survey by Money Management magazine this month shows that the charges levied by these personal pension plans will consume a large proportion of investors' contributions. Janet Walford, editor of Money Management, says: 'Some of the charges are so high that, ignoring the loss of a year's potential growth and the tax relief, consumers would be better off putting their money in the building society until April.'

Money Management compared the amount that would result from investing in a personal pension now and transferring the premiums to a stakeholder scheme in April with the amount that would be built up if you were able to invest the same premiums in a stakeholder scheme over the same period.

Only five of 48 pension companies surveyed - Equitable Life, Friends Provident, Marks & Spencer, Standard Life, and Virgin Direct - offer penalty-free switches from their personal pension to their own or other companies' stakeholder pensions. Two more - Legal & General and Nationwide - offer penalty-free switches to their own stakeholder plan, but switches to other companies' plans would involve penalties in the form of a lower transfer value.

Twenty of the companies surveyed - including Norwich Union, Royal Sun Alliance, Scottish Amicable and Scottish Widows - would provide transfer values worth less than 93 per cent of the premiums invested. In the case of the example used, 93 per cent of the £650 paid in premiums would be £605. These companies would not only fail to match stakeholder standards, but would also 'materially disadvantage' the investor, according to guidelines issued by the Association of British Insurers last year.

Scottish Widows, which is marketing its personal pensions as 'stakeholder standard', would charge the Money Management investor £101 for a transfer into its own stakeholder scheme; Scottish Equitable, which describes its plan as 'stakeholder-friendly', would charge £99; and Edinburgh Fund Managers, which intends to implement changes to fit in with the new rules when stakeholder plans are finalised, would charge a staggering £181.

However, Mark Birks of Royal & SunAlliance says there is a danger that pension investors will become so obsessed with pension charges, they will forget about investment performance. 'Of course charges are important when assessing different schemes,' he says, 'but the difference that a good investment management team can make to the overall return you can expect will dwarf charges over the long term.'

Stakeholder pensions: the facts

• Stakeholder pension plans are available to employees who do not belong to an occupational pension scheme, the self-employed and, for the first time, people with no earned income.

• You can contribute the higher of £3,600 (irrespective of earnings) or a proportion of your relevant earnings. The amount is determined by your age and level of earnings - from 17.5 per cent for people aged 35 or under to 40 per cent for those aged 61 and over.

• Total charges on a stakeholder pension will be limited to a maximum of 1 per cent a year - with no upfront fees.

• All stakeholder schemes must set their minimum contribution level at £20 or less.

• You will not be penalised for contributing irregular amounts, missing or stopping payments.

• Firms with five or more employees must offer a scheme for their employees if they do not already provide an occupational scheme or group personal pension for all their employees.

• They must deduct employees' contributions from payroll. However, they are not obliged to make contributions to the stakeholder scheme on behalf of their employees.

• Contributions will be paid net of basic-rate tax. Higher-rate taxpayers can claim higher-rate tax relief through their annual return. People who pay no or lower rates of tax will receive relief at the basic rate.

With so much at stake, your money could be better spent

People aged 40 or more with little in the way of savings could be better off spending their spare cash rather than investing it in a stakeholder pension, according to draft advice issued by the pensions and investment watchdog, the Financial Services Authority.

The FSA has drawn up draft 'decision trees', to help people decide whether they should invest in a stakeholder scheme or not. A decision tree entitled 'How much should I save for when I retire?' indicates that people aged 40 or more, who can only afford to save £20 a month, could receive a monthly pension of less than £47. This, combined with the basic state pension, is not enough to exceed the minimum income guarantee, a means-tested benefit which currently ensures that a single person receives at least £339.95 a month.

In guidance notes accompanying the decision trees, the FSA says: 'Particularly if you are over 40, have little pension or other savings and cannot afford to save much, the little you are able to put into a stakeholder may not be enough to bring your total retirement income above the MIG. It would then be wasted.'

Some pension providers and independent financial advisers fear this information will discourage the over-40s from saving. But Martin Campbell of Virgin Direct does not think the FSA has gone far enough in clarifying the situation: 'We would like the Government to state a minimum funding level for people of different ages - a clear benchmark showing whether it's in their interests to save in a stakeholder, or whether they should be considering an alternative form of saving.'

Someone saving a small amount in an Isa, for example, could use their savings to pay off part of their mortgage and thus prevent the money counting against their means-tested benefits after retirement.

In contrast, the low charges and flexibility of stakeholder schemes should prove advantageous to investors on average or higher earnings. The 1 per cent cap on annual charges is expected to become the industry norm for personal pensions, and the lower profit margins and increased competition between pension providers is likely to result in a flood of mergers and takeovers, making the choice of a specific stakeholder scheme easier.

However, Nick Bamford, of independent pensions adviser Cranleigh Informed Choice, says that even wealthier investors would benefit by keeping part of their savings outside of a pension scheme. He said: 'While the tax advantages of pensions are undoubtedly attractive, you cannot access any of your money until you reach retirement age. As you never know when you might need some capital, it's a good idea to put some of your money into an Isa or some other accessible investment scheme.'

• A new Trades Union Congress webpage contains information and can answer questions about stakeholder pensions.

• For the FSA's draft decision trees, visit www.fsa.gov.uk click on publications, followed by discussion papers and download PDF 1.23MM.