One question I’m regularly asked by new and prospective clients is how pension charges work. Despite the Financial Conduct Authority trying to make pension charging more transparent, it appears that there is still much confusion amongst the public.
Continue reading if you would like to understand how and what you are paying in pension fees (and if it is possibly too much).
There are three main types of fee to understand, plus a fourth depending on who is investing the money on your behalf. They may be shown separately or bundled together. I’ll deal with the three main ones first.
I’m talking here about defined contribution pensions, where you build up a pot of money. Defined benefit pensions work differently.
1. Administration fees
A pension provider or platform administers the plan. It keeps records, processes contributions and provides access to investments and retirement options. You might use a workplace scheme, an adviser platform or a provider you deal with directly.
The provider administers the pension under its scheme rules. Where the scheme uses relief at source, it claims basic-rate tax relief on eligible contributions. Other workplace arrangements give relief through payroll. Check your scheme’s terms rather than assuming every pension works in the same way.
2 – Portfolio Management Costs
Investment funds have running costs, often summarised in an ongoing charges figure, or OCF. These costs normally reduce the fund’s value rather than arriving as a separate bill.
Transaction costs and some other fees can sit outside the OCF. Ask for the full costs disclosure and check what is already included before adding charges together.
3 – Advice Costs
If you use a financial adviser, you may agree an initial fee, an ongoing fee or both. Payment might come from your pension or directly from you. Ask for the agreed charges in pounds and as a percentage where relevant. Do not assume you pay a personal advice fee just because your employer uses an adviser.
A financial adviser should be working with you to make sure your pension (and any other assets you have) are appropriate to your life plans and priorities. They might be recommending alternative funds, changes to your contributions, or advising how to generate an income from your pensions.
If you pay for ongoing advice, check the service agreement and what you have received. Ask the adviser to explain any gap. You can ask how to cancel future charges and whether a refund is due for services not delivered. Confirm what support would end before cancelling.
Bundled or unbundled charges
Some pensions combine administration and investment costs. Others show separate charges. Ask for a breakdown of the total and check for overlap.
Request details of any advice charge or legacy commission rather than assuming that it does not exist. Compare the same services across each option.
The Fourth Charge – Discretionary Fund Management
The additional charge that you might be paying is for a discretionary fund manager to make portfolio decisions on your behalf. They will buy and sell funds or individual company shares within pre-agreed risk tolerances and with specific objectives.
Check whether a separate discretionary-management fee applies and whether it is additional to the underlying fund costs. Ask what decisions the manager makes and what service you receive.
If you have a SIPP or platform-based pension it is possible that this is the case but you won’t be receiving these services unless you have been advised or agreed to it.
All In One Services
Some firms combine administration, investment management and advice. Ask for the total cost and the services included. If advice is restricted, ask what that restriction means for the products and providers the adviser can consider.
What should you be paying?
You can’t escape paying some fees because there are services you need. However, the more you pay, the harder your pension fund has to work to provide the capital you need for retirement.
As a broad guide, these are the annual fee ranges I would use when looking at the different parts of the service:
- Platform fees: around 0.15% to 0.4%.
- Advice fees: typically 0.5% to 1%.
- Portfolio fees: from around 0.2% to over 1%, depending on the funds and investment approach.
- Discretionary fund management (DFM) fees: from around 0.1% upwards, where a separate DFM service is used.
These are indicative ranges, not a quotation or a guarantee of what you will pay. Check the actual charges for your pension and the services included. Some of these fees can apply together, and transaction or one-off costs may be additional. Make sure you do not count the same cost twice.
To put percentages into perspective, an annual charge of 0.5% on £100,000 is £500; 1% is £1,000. This simple example assumes the value stays constant. It shows why I would always look at the cost in pounds as well as percentages.
Ask for administration, fund, transaction, advice and discretionary-management costs, plus any one-off charges. Check what each quoted figure includes.
Before transferring to reduce fees, check exit costs and any guarantees you would lose. A lower fee alone does not make a transfer suitable.
Cost vs Value
As with anything you pay for you need to be sure you are getting value for the charges you are paying.
Oscar Wilde defined a cynic as someone who knows the cost of everything but the value of nothing. By looking for the cheapest you might end up paying more in reparations but equally, when things are commoditised there is no point paying more than you have to. Pension administration has largely become a commodity and there are some very good companies, including some listed above, that provide a great service for a low cost.
Charges reduce what remains invested. With the same investments and performance before fees, lower costs leave you with more. That does not guarantee a higher return than a different portfolio: risk, investment choices and market movements also matter.
Naturally, as a financial planner, I would say advice costs are a value-added activity and are therefore worth paying, but only if you feel you are getting benefit from it. It might not be just in monetary terms but by having the sense that someone is helping you make important life and money decisions and acting as a guide for you.
Some people choose to make their own financial decisions and do so successfully. Just be aware of being penny wise and pound foolish; you might be saving a few hundred or thousand pounds a year in advice fees but what will the long-term financial and non-financial costs be if you make the wrong decisions because you don’t know what you don’t know?
If you would like to talk about your pension and financial planning please do get in touch for an initial, no-obligation chat. Or book time in my calendar here.
Photo by Austin Distel on Unsplash
