Beware of savings plans that lock up all your nest egg

Having invested into equity and bond funds over the last two years I can no longer put money regularly into my savings plan. I have some US$100,000 invested. What should I do? Let it sit there until I can afford to start investing again? Break it and incur the penalty of paying 25 years of fees up front but use the money for something else? AL, Dubai

Expert 1: Steve Cronin, founder of the financial education and support forum Wise,

People with 25-year savings plans keep them for just 7.6 years on average. So this question is very relevant for many.

These plans are like a nasty virus. You’re stuck with them for a long time and they are painful and expensive to get rid of. if you go anywhere near most financial advisers in the UAE, you are almost certainly going to catch one.

Why? Because advisers make so much upfront commission that they train themselves to be very persuasive. If you sign up to invest $1,000 monthly for 25 years, your adviser may get $12,000 immediately. That’s why AL is facing a large exit penalty.

So let me vaccinate you: do not ever buy such a plan, for five years or 25 years. AL would say the same, I’m sure. Now tell your friends, family and colleagues.

People with existing plans should consider how many years into the plan they are, then find out:

a) Which funds are being invested in

b) The maximum withdrawal amount without penalty

c) The full surrender value to exit the plan completely

Then they have several options:

1) Exit the plan and fight for reimbursement. There is a large penalty, with loss of most or all of the first 18 months’ investments. If it’s possible to demonstrate that the features, costs, surrender penalties etc were not properly explained, the product provider may reduce or waive penalties. Expect a fight. Some advisory companies in Dubai have sold savings plans without being licensed by the UAE Insurance Authority. Such policyholders could complain aggressively and may be reimbursed.

2) Exit the plan and reinvest on a cheaper, flexible platform. Taking a big hit is painful. But over 15 to 20 years, lower annual expenses will more than make up for a large initial hit. Try the free Investment Return Calculator at Investing in Vanguard or iShares passive tracker exchange traded funds (ETFs) offers better value, via an offshore platform like TDDI Luxembourg, Saxo Bank or Interactive Brokers.

3) Stop paying into the plan. Beware ongoing management fees and dormancy penalties (after 24 months) eroding what remains.

4) Keep the plan and reallocate funds. Some people prefer to keep paying in what they can and adjust the asset allocation to a sensible mix of stocks and bonds, regional diversification and slightly lower fund management fees.

Expert 2: Sam Instone, chief executive of AES International

Many people love or hate these plans but the only way to properly answer a question such as this is with statistical proof. A professional chartered financial planner will be able to plug the variables of your plan into a calculator and then provide you with an answer based upon factual evidence – not upon personal preference and emotion.

In most cases, the opportunity cost of remaining in a highly charged structure means it is often better to accept the exit penalty and reinvest the surrendered proceeds more efficiently. Good investment means no contractual lock-ins, no hidden commission and no high charges.

In our view, these regular savings plans which are often sold as “offshore pensions” or “children’s education funding plans” are outdated and many better options are available to the well-advised and astute international investor. In a minority of cases remaining invested in an existing plan but switching into lower cost or better diversified investments may make more economic sense.

Next question:

Rather than use a financial adviser, I’d like to invest directly into funds. What’s the best way to go about this and what pitfalls should I watch out for? GH, Dubai

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