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Q&A: pension charges explained

Labour leader Ed Miliband has attacked pension charges for being too high, but what exactly are you paying for?


by Michelle McGagh on Jul 24, 2012 at 09:30

Performance fees: If the funds that your pension is invested in do well then the fund manager could be in line for a performance bonus. This is typically a percentage payment if their fund exceeds a certain benchmark. Not all funds pay out performance fees.

Total expense ratio (TER): Following criticism of AMCs, many funds have starting providing a TER figure. This is the measure of the total costs associated with managing and operating a fund – including management fees, legal and custody fees. However, it is still difficult to glean a true picture of the costs because TERs do not include dealing costs.

Dealing charge: The more the funds your pension pot is invested in buy and sell shares, the higher the dealing charges will be. Depending on the fund manager’s style, they may buy and hold stocks – keeping them for a long time – or they may turn over the stocks frequently. The latter will cost you more money, so it’s worth investigating.

However, you also have to look at whether the returns on the fund justify the dealing costs. If the fund is making a stonking return then paying increased dealing charges may be worth it.

Dealing charges are being widely debated in the pensions industry at the moment as they can substantially bump up the cost of a pension – hence the 4% charge example that Miliband uses – but there are moves to bring the costs down.

Exit charges: Trying to get out of a pension contract could cost you dearly. Many contracts, typically those written in the 1980s, had exit penalties written into them. Whether you want to leave the pension contract because you have set up a new scheme or you have changed job, you should make sure you’re not going to get stung on the way out.

Adviser fees: If you received financial advice when you took out your pension plan, you may be paying for that advice out of your product. Even though many people believe advice is free, it is actually paid for through a commission that is paid from the pension provider to the adviser – and the money they use to pay it is taken out of your pot.

Under new rules advisers have to disclose exactly how much they charge for setting up your pension and discuss how you will pay for that charge. If your adviser tells you his advice is free, don’t be fooled.

Will I be charged for my workplace pension?

Workplace pensions do not, unfortunately, escape pension charges. However, you may be entitled to a discount on charges if you are an active member of the pension scheme, ie, you contribute regularly. 

In some schemes the costs you pay do not vary depending on the size of your fund, and you will have to keep paying them even if you no longer contribute. Some employers think it is unfair that those active members should subsidise those who leave the pension early and so provide an active member discount – this means active members pay a reduced annual management charge.

If you have an active member discount, you lose it if you leave your employer and subsequently leave the pension scheme.

Where can I get a low-cost pension fund?

A number of pension providers offer low-cost pensions, but the one you are sure to hear more about in coming months, and may even become a part of, is the National Employment Savings Trust (Nest). This is the government-backed pension scheme that has been launched to coincide with the government’s plans to auto-enrol millions of people into workplace pensions.

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6 comments so far. Why not have your say?

Rose G

Jul 17, 2012 at 15:19

The defined pension schemes may have been value for money, but now that they are on their way out, I do not believe ordinary people benefit from investing in a pension simply because the pensions industry is just as greedy as the rest of the financial services, and your investment is just as likely to enable the pension fund managers live their champagne lifestyle with paying out peanuts to you.

Milliband may not be trustworthy, but the pensions industry has more untrustworthy individuals - so no points for either, I'm afraid!

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A Sick SIPP Owner

Jul 17, 2012 at 18:04

From the example (s) given it's the 0.3% pa that causes pain - 40 years @ 0.3 is still 12% of the early years input.

I would look on something like the folowing to be a reasonable charging concept:

Paying-in fee - flat rate for each regardless of the amount.

Investment fee stamp duty + applicable taxes such as VAT

Annual fee - Associated documented government induced costs plus a small portion of the applicable PII and organisations running costs

That covers the costs of running the 'pot'

Add to that a percentage - 10%, or maybe 20% of the increase (or a deduction for a loss) of the fund's value over the - investors choice made at investment time - FTSE100, RPI CPI - LIBOR BoE Fixed term deposit rates rates - whatever fund type the investment was placed into as selected by the investor.

The idea being that input and running costs are covered and the managing organisation makes their money on a value-added basis.

No value added and the management get no pay and no profits.

Now - as an ARM investor I was expecting the management to take whatever was left after they returned the capital, with the specified growth or having paid me the agreed income,.

By my, admittedly rough, caclulations that should have left them with an anticipated income of at least 50% of the invested money from the later paying policies, less the effect of 10 years inflation and whatever extra premiums they had to pay for them .

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Chartered Accountant

Jul 17, 2012 at 18:58

It is sad to read comments like those made by Rose G. It is understandable why such views might be held, but nevertheless some additional comments might help. Firstly, long-term investors need to be invested in growth assets such as Equities or Property rather than Fixed Income, as it is only such growth assets that have any chance of providing real rates of return i.e returns that exceed inflation. However such assets are expensive to administer particularly if actively managed to try to beat benchmarks such as Equity or Property indices. Active management costs include both research analysts and investment managers who may often have remuneration structures that include a base salary plus a bonus that is tied to the results achieved and therefore has some equation with the interests of the investing clients. On top of this will be the cost of Record Keeping including regular reports to clients for which the rule of thumb number is usually 0.5% although increasing Compliance demands are driving that figure higher. Then there is an initial set-up charge which may vary between organisations and here the NEST figure of 1.8% will be at the low end of the market but this will be because they are offering quite simplistic and standardised indexation type products. The foregoing are costs within investment management organisations. On top of this will be charges by third party custodian banks which may be around 0.3%pa. Custodian banks are important because they hold the actual share certificates and therefore need to be notified whenever a trade takes place and these dealings are the subject of periodic reconciliations between the investment organisation and the custodian bank.

The point I am making above is that the whole investment process is not cheap. When markets are buoyant, such charges seem like money well spent. When markets decline, as recently, in say 1987, 2000 and 2008, the charges become a huge drag on what may often be already poor returns. One solution is not to invest anyway and just be content to receive interest on money in the bank. Not clever and if held in banks that themselves are in trouble, may also be highly risky. Another solution is to hold Fixed Income stocks that are widely touted as safe investments but may look anything but safe come the day when interest rates return to realistic levels of say 3-4%pa. Holding Equities in index funds may also be a low cost solution but again not ideal as the manager will take no action to disinvest or shift to other markets or sectors when economic storm clouds gather. With regard to active investment in say Equities, which commands the highest fees, when major market downturns occur, it is difficult for all but the smallest managers to disinvest as market liquidity dries up - but all the work in research and in making investment decisions will still have been made and may still be worth paying for if losses are mitigated against the alternative represented by index funds.

Financial services seem to be tainted by the actions of the massive short-term trading operations conducted mainly by the big banks although hedge funds may sometimes also be a disorderly factor in markets. However, the truth is that while normal active fund managers are well paid - particularly if they develop good performance track records - their remuneration is nothing like the examples being reported for traders out of the banks. However, if politicians genuinely wish to help pension fund returns, they could consider slowing down the incessant drip-drip of new tick-box type regulatory requirements which is causing Compliance to become a major cost; they could try to create an environment in which businesses (in which pension funds are invested) might flourish and if they feel that trading costs are too high, they could consider eliminating all dealing and other taxes within the investment process.

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Jul 17, 2012 at 22:36

1) The reason Nest will be index tracking is not the lower cost, it is because no end of studies in many countries have shown that over the long term such funds over perform 90% of the actively managed funds. Further more, Index trackers perform around the average while active funds are a gamble. The insurance against great loss comes free.

2) The AMC is of no concern to the investor and including it here defeats your purpose of simplifying things.

3) In spite of the existence of nearly all the different charges you have listed, there is no compelling reason why they cannot be combined in one.

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Jul 18, 2012 at 01:02

Stakeholders fees were not 0.5%. They were 1% AMC initially but then 1.5% AMC was allowed for first 10 years to help pay for advice/commission. But most IFAs preferred Personal Pensions with their more generous rewards etc. including residuals.

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Rose G

Jul 19, 2012 at 09:03

Hi Chartered Accountant

Thank you for trying to clarify the charging structure. Fresh as my mind is this early in the morning, you lost me completely.

I do believe that the pensions industry makes everything as clear as mud, just so that we will be forced to get advice from consultants whose vested interests are not declared, whose idea of investing is to loose client's money, while still continuing to charge for their services - if and when I am ready to invest my money, I will consider the risks and probably feel safer with leaving my money in a bank or building society in the UK, with the guarantee that upto £85K or so of my money will be safe.

I do not buy lottery tickets and so not likely to win a huge sum of money, I have a modest income of 30K or, have cleared all my debts except for the one credit card I use for travel and bigger purchases etc. My son & lodger's contributions I intend to save in an ISA towards a deposit for my son when he is ready to purchase his own home in the UK.

Being a low risk taker regarding finance, I certainly would look long and hard at any investment I make within the wider financial services industry.

That said, I did, sometime ago invest in an M&G fund, and would have liked to have continued, but life & the unexpected surprises it holds, meant that I cashed it in - I cannot remember the exact small sum I got in return for just over a years monthly contribution, but it definitely paid me back a little more than I would have got from an ordinary savings account.

I am by no means against investment, only it appears that rather than getting a return on your fairly safe investment, many people are making losses which they had not reckoned for.

To my mind the pensions industry has only itself to blame for the poor returns and for its equally poor reputation.

Having mades AVC into my occupational pension for the last 4 yrs, with another 4 to go, I am having to stop this as it was explained to me that I only got £ for £ of my contribution, with nothing to induce me to continue with this. This additional £250 or so a month will make a welcome contribution towards the saving for my son in a competitive ISA product, or I might just start paying into another investment product, which has a fairly low risk.

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