Take a more direct approach to your pension

With many corporate pension schemes now in the red, pension holders might consider investing instead in a fund they can control themselves, writes Fiona Reddan

WITH IRISH managed pension funds down by 20.8 per cent in the 12 months to June, investors might wonder if they'd be better off managing their pensions themselves.

While many corporate pension schemes are in the red, members of the Arnotts pension fund received a €50,000 bonus last Christmas when the trustees decided to distribute €100 million of the surplus in the fund.

Unlike most company funds, which are run by investment institutions, the Arnotts fund is self-managed.

Self-managed or self-directed pensions (SDPs) enable a pension holder to take complete control over their retirement by directing how their pension fund is invested and managed.

Pat Ryan, head of pensions with Canada Life, says they are suitable for people who want to make their own decisions regarding their money.

"Self-directed pensions are suitable for anyone who's prepared to take a risk with regards to their pension, who like an element of control, and who can pick something they understand to invest in," he says. "It's for people who are looking to treat their pensions a bit more like their own money."

But are SDPs suitable for everyone? Typically, it is high-net worth individuals or company directors with financial experience who want to manage their own pensions, but these schemes actually cater for a far wider audience.

According to Ryan, PAYE employees seeking greater control in managing their retirement are increasingly choosing SDPs. He notes that employers are now willing to facilitate employees by paying contributions into their self-directed schemes rather than the company pension scheme.

SDPs currently represent up to 40 per cent of Canada Life's individual pension business.

Some pension holders have been dissuaded from going down the DIY route due to the level of investment required to get the funds up and running. Typically, these funds require a minimum investment of €50,000 or an annual contribution of about €20,000.

Eoghan Creevey, head of unit trusts at Harvest Financial Services, recommends that investors either make contributions of €30,000 a year or start with a fund worth about €100,000.

"Anything less than that can be difficult to diversify," he says, adding that the average self-directed fund administered by Harvest is worth about €250,000.

The major advantage of SDPs is that investors can access a more extensive range of asset types than traditional schemes, including equities, private equity, government and corporate bonds, collective investment vehicles, commodities, currencies and property.

"Equities and property are the most commonly invested assets," says Creevey, although he adds that private equity deals are also popular.

Investors with self-managed pensions can also benefit from stronger performance than typical managed funds.

"The upside of self-directed funds is that greater leverage can accelerate your gains," says Creevey.

It is also easier for investors to react to current market performance. Creevey has noticed a move among some investors to put this year's contributions into cash deposits.

One of the attractive aspects of a self-directed pension is that it allows investors to purchase property through their pension policy, subject to certain restrictions.

In 2004, legislation enabling pension holders to borrow against their pension to buy property was introduced.

Under the scheme, holders of self-administered pension schemes or self-directed trusts can borrow up to four times their pension to fund a property purchase.

While pension holders can invest in property anywhere in the world, Ireland, Britain and Germany are the most attractive due to their tax regimes.

Pension holders can also invest in property syndicates, which is particularly popular, according to Ryan.

Banks can only lend on a non-recourse basis to a pension fund, so they cannot ask the pension fund holder for an individual guarantee and can only use the pension fund assets as collateral.

For those looking to benefit from a property investment upon retirement, such a strategy is more attractive than buying a property directly. By investing through a pension policy, the pension holder will be able to avail of tax advantages such as a tax-free initial deposit and the accumulation of tax-free rental income, while no capital gains tax is due upon disposal.

"Because of the tax allowances, it is much easier to pay off a mortgage when it's purchased through your pension, as your contributions benefit from tax allowances and your rental income is allowed to build up tax-free," says Ryan.

Creevey says buying property through a pension has become popular because people have realised they can use pretax income for property investment. "It fits in well with the Irish psyche," he adds.

However, investors cannot invest in assets they already own themselves or, for example, buy a holiday home through their pension and then use it themselves.

SDPs also have downsides. They can be time consuming and they require a certain level of financial knowledge on the part of the pension holder.

While both Ryan and Creevey say some self-directed schemes have performed exceptionally, others have not matched the performance of managed funds.

"Although the rewards might be higher for self-directed schemes, the risks are also greater," says Ryan, adding that SDPs tend to be less diversified than their group counterparts.

The cost of running a self-directed fund is also slightly higher than a managed fund, as individual pension schemes do not benefit from the same economies of scale.

SDP holders must appoint a pension administrator, such as Eagle Star, Quinn Life or Canada Life, and such firms typically charge an annual management fee of about 0.5 per cent to 1.5 per cent, depending on the level of investment advice and service required.

These firms may charge a set-up cost of between €500 and €1,500, while pension holders must also pay for dealing charges, which vary from stockbroker to stockbroker.

While product charges may be competitive for people with large amounts to invest, a disadvantage for those with smaller pension funds is that these charges may eat into their returns, as they cannot avail of the lower charges big pension fund managers benefit from. However, charges for other individual pension schemes can also be expensive. Personal Retirement Savings Accounts (PRSAs), which were introduced in 2003, can charge up to 5 per cent on contributions, as well as a management charge of 1 per cent a year. Overall, this works out as an annual charge of 2 per cent.

An SDP can be established as a new product or investors can generally transfer money from an existing pension into an SDP. However, there may be fees associated with such a transaction.