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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

From October people who are not currently part of a workplace pension will be auto-enrolled in to one, and if the company does not have one then they have to start one. Many companies which don’t currently run employee pensions are expected to adopt Nest as their scheme.

Nest members will pay a 1.8% charge on the value of each contribution to cover Nest start-up costs; if you paid in £100 a month, £1.80 of that would go to Nest. An annual management charge of 0.3% of the pension fund will also be levied.

Nest has said it will adopt a passive investment strategy, which means money will not be actively managed by a fund manager but will be invested to track certain stockmarkets, keeping the costs low.

What can the government do about high charges?

With the creation of legislation that governs Nest, the government was given powers to cap pension charges for all pensions. However, it is keeping this card in its back pocket, and has told the pensions industry to sort out the problem itself.

The National Association of Pension Funds is already working on a code of conduct to ensure that charges on defined contribution pensions are clearly and accurately stated to help employers pick the right pension scheme for their employees. The code is currently being consulted on and is expected to be launched in the summer.

The Association of British Insurers, which has accused Miliband of ‘scaremongering’ over pension charges, has also said it will help instil fair costs into pensions by examining the use of exit charges. However, it maintains that exit charges are a hangover from older, more expensive pension schemes, and are rarer nowadays.

Pensions minister Steve Webb has fired a warning shot at pension providers, telling them to review their 'back book' of pensions and bring down high charges and scrap exit fees, which take a big chunk out of your pot if you try and leave the scheme, meaning people are 'locked in' to expensive pension schemes.

There is particular concern from the government about the high charges on default funds - into which your pension money is automatically invested if you do not make an active choice about investment.

Webb has urged pension providers to 'look again' at older pension contracts. Writing in the Daily Telegraph, he said: 'They should ask themselves how many policyholders they have who have pensions on term that they would not dream of offering to new customers.

'And they should ask themselves if the battered reputation of their industry would not be greatly enhanced if they were to revisit these schemes and offer scheme members fairer terms.'

Although Webb said the government does have the power to cap pension charges, implementation is more difficult as what charges are included in the cap need to be determined, and there is a concern that low cost pensions scale their charges up to the cap.

'I remain determined to make sure that every pound that [savers] put aside is turned into the maximum possible amount of pension,' Webb said. 'And if further measures are needed to clamp down on charges, then we will not hesitate to take them.'

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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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