Beware obstacles that could knock wheels off your pensions vehicle

The row over excessive pension costs has escalated after the government warned providers that it could impose a cap on the fees they charge investors. Recent claims that excessive and often hidden pension charges are ravaging pension savings have been angrily rejected by the industry. However, the issue was tackled in parliament this week as MPs tabled a motion calling for the government to tackle pension fees, prompting pensions minister Steve Webb to raise the prospect of government action on charges (see panel).

The Treasury was warned recently that pension savers are being deprived by fund management firms of thousands of pounds in savings because of hidden and frequently high fees.

It was told that thousands of people are retiring with far less than they had expected, with some getting less back than they had invested once charges had eaten into diminished investment returns.

However, the investment and pensions industry has insisted that the extent to which charges affect investment performance is being exaggerated.

Suggestions that charges leave investors with vastly diminished returns have been dismissed by the Investment Management Association (IMA) as “scaremongering”.

Richard Saunders, chief executive of the IMA, said: “People need to save for the long term. They do not need to be scared off by false stories that if they do so they will be ripped off by the industry. If the accusation were true, it would show up in the net returns achieved by investors. But there is no sign of it. The accusations of hidden charges do not stand up.”

Charges vary hugely between provider and the type of pension taken out, as new research by Money Management magazine illustrates.

It found that someone investing £200 a month over 25 years into a balanced managed with the lowest charges would build a pension pot worth £146,863, assuming typical growth. A saver paying the same into the most expensive balanced managed fund would end up with a pension pot more than a fifth lower, at £115,158.

Charges are not the biggest factor determining pension returns – how much you invest, how long for, and the quality of the investments chosen are more significant.

But Neil Lovatt, sales and marketing director at Scottish Friendly, believes anyone who denies that charges are a major issue is “kidding themselves”.

“Soft and semi-hidden charges do nothing to help convince investors that they can trust pensions to lock away their savings for decades. Indeed, the prevaricating from some quarters of the chattering classes about ‘full disclosure in page six of the fund details’ is beginning to sound more like Vicki Pollard’s ‘yeah but, no but’ than a mature and open approach to a serious industry problem.”

Industry groups have admitted more transparency is needed. The National Association of Pension Funds has called for a reform of the way in which charges are shown to investors, while the Association of British Insurers has also set out proposals to improve the way charges are set out.

But where does that leave pension savers in the meantime? Part of the problem in working out how much you’re really paying is that if you took out your pension some time ago, there’s a good chance it’s now being looked after by a different company.

Mike Amphlett, partner at Perth-based Comparemypension.com, explained: “This means lots of legacy system problems and often complex business models. These changes mean that there are many different charging structures applying to pension plans depending when you took the plan out, whether it’s with a closed or open-for-business provider and how much you have in the pension.”

But it goes deeper than that, said Tom Munro, owner of Tom Munro Financial Solutions.

“In my experience, the largest contributor to the derisory take-up of UK pension savings is undoubtedly the ‘smoke and mirrors’ marketing models adopted by virtually all traditional life offices over the past 25 years or so,” he claimed. “Capital units, hidden expenses, excessive fund management and administration charges, along with colossal funded initial commissions to greedy advisers have resulted in a huge drag on performance, leaving investors with poor performing vehicles over long-periods of time.”

Add to that the multiple pensions held by the growing number of people who have worked for several different employers, and tracking down pensions can be tricky enough, let alone finding out how much you’re paying.

There can be several layers of charges, some affecting the investment more than others. Perhaps the easiest to identify are administration charges.

These tend to range between 0.8 and 1.2 per cent of the fund value a year, with the newest plans usually the cheapest.

“Contemporary, competitive charges can be as low as 0.4 per cent and reduced further for larger fund values,” said Amphlett. “Self-invested personal pension (Sipp) charges are higher than standard personal pension charges and a typical benchmark is 1.5 per cent, although monetary charges are often used.”

Then there are fund management charges – and this is where much of the controversy lies. Annual management charges (AMCs) tend to be around 1 to 1.5 per cent, with the latter increasingly considered expensive and 2 per cent AMCs now limited to specialist investment options or rip-off merchants.

Pension providers with “in-house” fund management are usually - but not always - cheaper.

“There are now thousands of funds from hundreds of managers available,” said Amphlett. “The most expensive fund managers will claim that you get what you pay for – your net return will be higher. Some will include the cost of in house fund management in an increased administration charge.”

Trading costs – incurred in the buying and selling of holdings – can add significantly to the total cost.

Trading costs are important and can vary significantly between funds. Typically, they should be reflected in the total expense ratio (TER), which is perhaps the most relevant figure for investors to look at, but the extent to which they are is difficult for investors to gauge.

“For passive, index funds the trading charges will be low and the reduction in yield given is a reasonable proxy for the TER (it could add 0.1 or 0.2 per cent),” Amphlett said: “But for many actively managed funds the trading costs could be high and while the annual management charge could be 1 per cent, the TER might be double.”

IMA research published yesterday aimed at rebutting claims of high and hidden trading costs found that transaction costs for the typical actively managed UK All Companies fund were 0.31 per cent per cent of average assets. Of that, two-thirds was accounted for by stamp duty. Transaction costs for tracker funds came to 0.06 per cent.

It’s more likely that the extent of the charges you pay is dictated by how old your pension plan is. Millions of investors with pensions that were taken out in the eighties and nineties are now paying charges far higher than they would on newer plans.

The introduction of stakeholder pensions in 2001 helped matters, but many people remained on older, more expensive terms.

“Those that are still paying the old rates could be paying anything up to 1 per cent more than others invested in the same fund with the same provider but using a more recent pension plan,” said Amphlett.

If you’re among them, you could be losing thousands of pounds to charges.

A 1 per cent saving for someone with a fund of £20,000 adds up to £14,410 over 25 years, assuming a growth rate of 6 per cent. That saving is greater if contributions are still being paid in.

Amphlett said: “People who have pensions more than a few years old should ask their providers what the charges are for all the components of their plan – a realistic benchmark should be less than 1 per cent,” he said. “Everybody needs to understand the funds [and costs] their pensions are invested in and ask themselves whether they are in the best place.”

EXAMPLES

1 You have £50,000 in a pension but are not making further contributions and there’s 25 years until the fund is accessed. Using a 5 per cent growth rate (typically used by provider pension projections) comparing overall charges at 1.75 per cent against 0.75 per cent:

1.75 per cent charge produces a fund of £109,000

0.75 per cent charge produces a fund of £140,000.

2 You have £50,000 in a pension, making contributions of £200 a month with 25 years until the fund is accessed. Using a 5 per cent growth rate (typically used by provider pension projections) comparing overall charges at 1.75 per cent against 0.75 per cent:

1.75per cent charge produces a fund of £199,000

0.75 per cent charge produces a fund of £244,000.

Source: Comparemypension.com