Jeff Salway: Should I stay or should I go? Don’t panic over pension puzzle

Published on 22/07/2012 00:00

SUPPORT is building for action on exit penalties that leave savers trapped in expensive pension plans, after fresh controversy erupted over charges.

In a series of pension policy proposals outlined last week, the Labour party called for greater transparency in the disclosure of charges and an amnesty on exit penalties for existing pension plans.

It argued that making it easier to switch plans would help investors take control of their retirement funding and get better value for money.

But Labour leader Ed Miliband came under fire from the pensions industry after accusing pension providers of ripping off savers with charges reaching 5 per cent.

Miliband’s comments were dismissed by the Association of British Insurers as “hugely misleading”. Fees have been falling over the last decade, it said, with the average Annual Management Charge (AMC) now just 0.77 per cent.

However, RSA, a think-tank, said nine out of ten pension fund managers were keeping savers in the dark as to their full levies. It claimed that fees could account for up to £40 in every £100 of pension savings.

So who’s right? Are pension charges eroding your retirement pot excessively or have the industry’s critics got the wrong end of the stick?

The answer, inevitably, is far from straightforward.

For instance, how much you pay depends partly on how old your pension contract is. If you took out your pension policies over a decade ago you’re likely to be paying more, as the ABI admitted.

Steven Dunn, head of pensions at Anderson Strathern, said: “Individuals with old pension schemes which commenced before the introduction of stakeholder pensions may still be set up with the original (and higher) AMC and, as such, should seek advice on switching to different schemes with lower charges.”

But there are the other costs to factor in: “Where the Labour report does seem to have a point is not in relation to AMCs for particular pension schemes but to the total expense ratio of the underlying funds in which members might invest,” Dunn explained.

The Total Expense Ratio (TER) is a better guide to the costs you actually pay on pensions and investments, yet it’s often buried deep in the paperwork. The TER – the measure approved by the regulator – includes the AMC and stamp duty plus legal, administration, audit, marketing, regulatory and other fees.

TERs tend to come in at around 1.5 to 2 per cent on unit trusts and open-ended investment companies. The average is closer to 1 per cent on investment trusts, dipping below that in some sectors.

Dunn said: “Pension savers may be aware of the headline AMC figure, but very few are likely to have even heard of the TER, let alone know the actual figure for their investments.”

The higher costs tend to come on funds with high trading levels, he added.

“That may argue in favour of using tracker funds for pension investments, with all the pros and cons that that entails. However the potential outperformance an active fund may have against its benchmark could conceivably justify the fund’s TER,” Dunn said.

One way of judging whether you’re paying over the odds is to view your charges in the context of the stakeholder level, believes Mark Thornton-Smith, a financial planner at Cornerstone in Edinburgh.

“Although stakeholder pensions have not been a great success, they have brought more awareness with regards to what reasonable charges for a pension should look like,” he said.“Under stakeholder terms the maximum annual charge is 1.5 per cent a year, falling to 1 per cent a year after the first 10 years. How does this compare with your contract?”

Regardless of the kind of plan, it’s well worth checking how much you’re paying for your personal and/or workplace pension. Over years of saving, the impact of high charges on the pension pot you end up with can be massively damaging.

Unfortunately, however, exit penalties mean that shifting to a new arrangement isn’t always straightforward.

Penalties on older plans in particular can be extortionate, making it harder to weigh up whether it’s worth transferring. Exit penalties are increasingly outdated, however – you’re far less likely to be charged on exit if you took out your contract over the past decade or so.

“Although virtually all pension contracts will allow you to transfer to an alternative arrangement after you have sought financial advice, there are a number of different types of exit penalties that could be applied,” said Thornton-Smith.

For example, with-profit policies often levy Market Value Reductions (MVRs), effectively exit penalties that can reach up to 10 per cent.

“There could also be penalties applied by the provider as a claw-back of charges that were arranged to be taken from your contract up until the date you retired,” Thornton-Smith added.

Financial advice is highly recommended, given the potential complexities around both the charges you pay and the cost of transferring to a new pension.

As Bill Saunders, head of financial planning at Acumen Financial Planning, pointed out, savers can be stuck between a rock and a hard place when working out their options.

“If you stick with the current provider, the performance and fund choice is often poor, and to add insult to injury the ongoing charges are often high. If you transfer the fund elsewhere, you can lose a huge percentage in exit fees,” he said.

That doesn’t mean there’s nothing you can do though. If you’re in an underperforming fund that’s expensive to exit, you could cease paying into it and instead save into a low-cost alternative.

“At the very least do not reward the provider by paying in regular contributions, but direct these instead to a modern, low-cost plan,” said Saunders.

And remember that for all the controversy over charges, the pension you end up with is dictated more by other factors.

“The greatest influence on a successful pension is to set aside an appropriate amount every month and never miss a beat. Accomplish that and 90 per cent of the job is done,” said Saunders.“Then look to see if existing arrangements can be run more cost effectively.”