Are you being robbed by pension charges?
"People need to get more bang for their buck, or they are not going to bother."
This tough message, from Lord McFall, chairman of the Workplace Retirement Income Commission, came as he presented a report in August into pension saving, and refers in part to the danger of high plan charges deterring savers from using pensions to save for retirement.
His committee's recommendations, which relate to the planned launch of automatic enrolment of employees into workplace pensions in 2012, include a request for a cap on charges - at 1.5% - which it suggests will help limit the damage to the value of retirement pots over time.
These proposals follow hard on the heels of a controversial report issued by Consumer Focus in July that suggested some independent financial advisers have been busily persuading pension customers to switch to new plans, at higher annual renewal commissions (known as 'trail'), before commission is banned by the Retail Distribution Review at the end of 2012.
While several critics, especially IFAs, lined up to pour cold water on Consumer Focus's findings, citing lack of real evidence, the Financial Services Authority, the regulator, has previously warned about the risks to consumers of such 'churning' activity.
Switching pension schemes can sometimes be the right move, so long as the new investments are appropriate, the exit penalties are not severe and there is no loss of any valuable future benefits such as a guaranteed annuity.
Malcolm McLean, pension consultant at actuaries Barnett Waddingham, says: "Modern arrangements allow an individual to switch between pension providers free of charge and without penalty. If an individual is paying high fees they should look to renegotiate with the provider or investigate transferring elsewhere."
Typical annual charges for pensions are between 1 and 1.5% a year - although they can be higher, especially for more tailored self-invested personal pensions (SIPPs). This is in addition to any set-up charges you may face, which range from zero to hundreds or even thousands of pounds for complex or high-value funds.
A difference of a percentage point or less in fees may not sound much, but over a lifetime can result in a sharply-reduced return and a lower income in retirement.
McLean calculates that a 35-year-old contributing £200 a month into two identical pension arrangements, both with an investment return of 7% a year, but one with an annual management charge (AMC) of 0.6% and the other with a 1% charge, would retire after 30 years with £211,000 and £196,000 respectively.
That seemingly insignificant extra 0.4 percentage point deduction will dent the final fund by £15,000.
What else to watch out for
It is not just the plan charges you need to watch out for. Most pension plans invest in collective investments such as unit trusts, which carry their own management and additional administration costs that also eat into returns.
It can also pay to be wary of certain investments that add extra layers of charges, such as those imposed by providers that outsource investments to other firms or put your cash in to multi-manager funds (funds of funds) that incur double AMCs, thereby eating further into the pot.
And there are some fund managers who like to buy and sell their holdings more regularly than others, adding extra trading costs to the mix.
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
Investment funds that invest in other investment funds from a wide range of asset managers and are often referred to as funds of funds. Some multi-manager funds only invest in the funds of the investment house providing the fund of funds and these are known as “fettered”. An “unfettered” multi-manager fund is free to invest in what the fund manager believes are the top performing funds from across different markets and industries. Investing in multi-manager funds means your risks are spread across geographical regions and industry sectors but it also adds another layer of charges and some multi-managers also levy an out-performance fee.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.