How the downturn is going to hit us all in the pocket

It's official: the economy is shrinking and we are heading for a recession. Teresa Hunter looks at what we can expect

WITH-PROFITS FUNDS

INVESTMENTS in millions of with-profits contracts took a hammering when Norwich Union and Friends Provident announced they were introducing exit penalties, while Legal & General imposed savage cuts on payouts.

Legal & General has sliced between 5% and 9% off the final bonuses they had already announced, on account of the white-knuckle ride they have taken on stock markets.

This means, for example, that a 20-year £200 monthly pension contract will pay out £90,999 at maturity, compared with the £98,511 the policyholder may have been expecting.

But with-profits pension, insurance and bond investors who wish to get out before other insurers do the same may have already left it too late. Norwich Union and Friends Provident have joined other leading insurers who, as we reported on September 28, were already introducing exit fees.

This will come as grim news, as Norwich Union had been the only major company which did not impose so-called Market Value Reducers (MVRs) on any of its products.

Friends Provident has followed its lead by extending exit penalties of between 5% and 14% to around 250,000 mainly pension policyholders.

With-profit policyholders already feel aggrieved by lacklustre returns. According to Money Management's latest with-profits report, while top-performing companies such as the Prudential have returned 8% annually for investing £200 monthly into a 10 or 15-year pension policy, the average annual reward was just 3.9% over 10 years and 5.7% over 15 years.

The new Norwich Union MVR will cut the value of a policy by up to 22% on unitised with-profits pensions and bonds if you try to cash them in. This comes on top of contractual early surrender penalties, and follows earlier moves by Legal & General, the Prudential, Scottish Widows and Standard Life.

Scottish Widows was already charging MVRs on with-profits bonds, but it has broadened the net. It now estimates six out of 10 of its with-profits investors will be hit by an MVR if they leave early, with pensions reduced by between 15% and 20% and life contracts by 10% to 15%.

Standard Life admitted its MVRs can be up to 25% on some pensions policies, and the Prudential added that while the situation is constantly under review, there are no plans to increase encashment charges.

Hargreaves Lansdown head of pension research Tom McPhail says: "The headline figures don't tell the whole story and many investors, particularly regular savers in pensions, may have modest MVRs or even none at all.

"That may not remain the case for long, so they may want to consider transferring their money elsewhere now. The exception is investors close to retirement, who should probably stay put."

There is little that pension investors can do to avoid the penalties other than sit it out until retirement, but bondholders can sidestep MVRs with careful planning.

Most companies allow penalty-free encashment of income paid on the fund each year, or up to 7.5% in the case of Scottish Widows, LV, Axa and Aegon. Many also permit MVR-free withdrawals on key anniversaries such as five or 10 years. But contracts differ, so check the small print.

CREDIT CARDS

IT'S time to cut up your credit card as the cost of plastic is soaring. A third of plastic issuers have cut the interest-free period by up to 11%, costing shoppers £3m extra in interest payments.

A wide range of affinity cards, including football clubs, the British Heart Foundation and National Trust have reduced the interest-free period from 56 days to 50 days, along with the Dunfermline Building Society, MBNA and the Unicef Credit card. Alliance & Leicester has reduced the interest-free period from 56 to 53 days.

According to uSwitch, the best cashback cards are American Express, which pays 5% cashback for all spending during the first three months up to £4,000. Egg Moneymaster card pays 1% cashback.

If you are looking for easy purchase, Bank of Scotland, Barclaycard and Marks & Spencer each charges no interest for 10 months, but after that the interest is between 15.9% and 16.9%.

Simeon Linstead, head of personal finance at uSwitch.com, says: "As consumers are likely to only start feeling the full impact of the global financial meltdown in 2009, now is not the time to be naive when shopping around for a new credit or lethargic when it comes to reviewing existing borrowing.

"It is vital you give yourselves the best possible chance of successfully repaying debt in the tough times ahead by planning now to secure the best deals on the market. Remember, the more money you spend on fees and charges, the less you are paying off the actual debt."

The price of transferring between cards is rising, with nine out of 10 balance transfer cards levying a fee compared with two out of 10 a few years ago. Fees have soared by 373%.

And don't get stuck without cash, as withdrawing on your credit card will cost a typical 29.97% – 40% higher than a few years ago.

Annual fees too have increased by 82% to nearly £100.

MORTGAGES

THE long Chinese burn continues for homebuyers, despite the Government's pledge that banks will be forced to return lending to 2007 levels.

Large lenders have pulled their tracker loans, others pushed up the prices, and many lenders show no sign of passing the recent base rate cut on to borrowers.

Skipton, Leeds and Alliance & Leicester all withdrew tracker mortgages, while Nationwide put up the cost on some loans by 0.7% in the wake of similar rises by Woolwich, Abbey and C&G. Skipton also announced on Friday that it would not be passing on the 0.5% base rate cut to its standard variable borrowers. Nationwide tracker borrowers without large deposits are now paying more than they were a few months ago.

The problem for lenders is that the rate at which they must borrow to fund their loans, Libor, is creeping down only painfully slowly.

While HBOS and RBS – now closely linked to the Government – quickly announced mortgage rate cuts in the aftermath of the base rate move, others without taxpayer backing have not yet announced a move.

Charcol's Ray Boulger said: "There is a feeling that perhaps this time, because of liquidity constraints and the slowness of Libor to respond, many lenders may sit the cut out and change their rates next month after the further anticipated rate reduction."

So where does this leave borrowers worried about their mortgage repayments? That depends on whether you believe that the action the Government has taken to restore confidence will work.

If it does, then Libor should continue to fall, paving the way for lower borrowing costs. In this case, borrowers would be advised to wait to switch to a new cheaper deal.

If the Government's action fails, then lenders may continue to push up their margins. If so, borrowers may wish they had snapped up the deals currently on the table.

THE POUND

ANYONE planning a Christmas shopping trip to the US or even to Germany and central Europe might be advised to put their plans on hold, after the pound suffered its biggest one-day fall since Black Wednesday.

It fell 2.3% against a basket of currencies after Bank of England Governor Mervyn King warned that the UK was heading for recession in the expectation that interest rates will have to fall sharply to kick-start the economy.

The dollar fell slightly on Friday, after climbing to a five-year high against sterling.

Nevertheless, the price of holidays will climb next year, with American Express predicting that the cost of flights could be up by 9%. As the economy tightens, airlines are expected to squeeze passengers even harder by making them pay separately for items such as checked baggage and food and drink.

Elsewhere, Co-operative Travel boss Mike Greenacre has called for a consumer protection regime for the travel industry in the light of the collapse of budget firms such as XL and Zoom. Further collapses are anticipated.