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How to solve the dilemma of pensions charges
A new report has criticised the pensions industry for failing to disclose charges, and says the government should help explain the costs.
by Michelle McGagh on Jul 19, 2012 at 10:18
A timely report on pensions charges shows the extent to which pension pots can be eroded by costs, and accuses pension providers of ‘maintaining a fog’ around what consumers pay to save.
The report by the Royal Society for the encouragement of Arts, Manufactures & Commerce (RSA), which was sponsored by Dutch pension fund APG, reveals that even modest fees of 1.5% can make a significant dent in a pension pot.
It gives the example of a 25-year-old who plans to retire at 65, and enjoy a pension for the next 20 years. They save £1,000 a year into a pension, increasing the amount in line with inflation of 3%, and they receive a 6% return on their money.
By age 65, without any fees, the pension pot will be worth £248,170, which will create an index-linked pension of £16,080 a year.
However, if they have to pay out 1.5% a year in charges that reduces the retirement income to £9,900 a year.
The truth is that there will always be a cost to pensions; if you invest for 25 years then the costs will be significant. One of the best comparisons is mortgages. People are willing to pay substantial interest for the privilege of taking out a mortgage and owning their own home – so they should accept that they won’t get a pension for nothing.
Issue of transparency
Although costs have to be accepted as part of the process, the transparency of those costs leaves a lot to be desired. Investors who are keen to understand what they are paying for their pension are often stumped by the lack of information on charges and the inability to compare pensions.
The report notes that the inability to compare pensions is a result of charges being rolled together, rather than explained individually.
‘Compounding of charges is one reason why investors have such difficulty in distinguishing between one pension and another. It is simply not made clear to them that a pension provider with a charge of 0.5% will, all else being equal, provide a pension which is a third higher than one which charges 1.5%,’ said the report.
Most pensions show the annual management charge (AMC). Although the AMC is cited as the cost of the investing your money, it does not include audit, custodial and other costs which are charged separately. In a bid to aggregate charges, pension providers are now quoting the 'total expense ratio', but this still does not give you the full picture.
There are still taxes, broker commissions and the dealing costs to be added on top.
The difficulty with extracting the exact cost of a pension is due to providers being unable, or unwilling, to provide the information.
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