Revealed: The scandal of how pension providers rake in the money
Britain's industry charges some of the highest management fees in Europe, which results in savers losing thousands of pounds in charges over the terms of their policies. Maryrose Fison and Julian Knight investigate
Sunday 12 December 2010
It's a fact. Greedy pension companies are siphoning off great swathes of pension money in the form of sky-high management charges. While legal, the practice employed by UK pension funds has been exposed as being among the worst in Europe with Britons frequently paying up to four times the amount paid by their neighbours in Holland and Denmark.
On the face of it, the charges levied by these firms appear meagre – typically 1.5 per cent of a pension fund's value. But number-crunching reveals the truly devastating effect such charges have over time. An influential report published by the Royal Society for the Encouragement of Arts, Manufactures and Commerce (RSA) last week showed that over the life of a pension – 25 years – an individual saving into a scheme which charges 1.5 per cent in annual management charges will see a staggering 38 per cent of their income gobbled up by fees.
Put into context, this equates to a 60 per cent increase in yearly retirement income for someone who saves £1,000 per year until they are 65 and who receives an average return of 6 per cent. Before fees, their yearly retirement income would have been £16,080, up from a mere £9,900 if a 1.5 per cent charge is applied.
In a week where the pensions landscape looks to have shifted again – with the proposed ending of the need to purchase an annuity by age 75 removing a barrier for many to pension saving – there are potentially low-cost alternatives to the traditional pension. Here's what's on offer:
Keeping it simple
It may not have all the bells and whistles that other pensions have, but with its simple structure and guaranteed cap on management fees, the stakeholder will be the best option for many. Government rules means that stakeholder providers are not allowed to charge more than 1.5 per cent in annual fees for the first 10 years and no more than 1 per cent thereafter. However, shopping around reveals many providers are now offering the product for as low as 0.8 per cent.
Martin Bamford, the managing director of IFA Informed Choice, says people willing to compare products online and forgo financial advice may find they can reduce costs further.
"In practice, if you are not receiving advice when you set up a stakeholder pension you should be looking at a much lower management charge than 1.5 per cent," he says. "Because within that 1.5 per cent, typically there is at least half a per cent which goes towards cost of advice, so if you went directly to a provider you should really be looking at charges of 1 per cent or lower."
Mr Bamford calculates that a 25-year-old woman who contributes 5 per cent of a £22,000 salary to the Aviva stakeholder pension – which charges 0.9 per cent in an annual management fee when purchased online – could expect to have accumulated a fund worth £174,000 by the time she reached age 65 assuming an average annual return of 7 per cent. Over this period, the management charge would have taken £47,300 – significantly less than the £55,254 had she opted for a scheme with a 1.5 per cent charge.
Many see self-invested pension plans (Sipps) as the expensive preserve of rich and sophisticated investors, but this isn't necessarily so. With a Sipp, investors pick which investments they want to make with their pension pot, so there are obvious risks. But if you get these choices right and hold investments for the long term – not chopping and changing – then fees can be manageable and even lower than a more mainstream pension. In fact, there are a number of low-cost Sipps on the market, not requiring hefty up-front fees. Unlike stakeholder or personal pensions, management charges are generally expressed as a one-off fee – on average around the £150 mark – and an annual charge of between £150 to £600 depending on the amount of investment choice an individual desires.
"If you want to invest in a simple range of funds and some exchange traded funds (ETFs) you pay a lower fee, but if you want to invest in things like commercial property and stocks and shares there might be higher fees involved," Mr Bamford says.
Mr Bamford calculates that if a 20-year-old woman contributes 5 per cent of her £22,000 salary to Sipp provider AJ Bell's e-Sipp, she would have a fund of £211,384 by age 65 assuming growth of 7 per cent.
Group personal pensions (GPPs) can be an excellent, low-cost option with many plans offering annual management charges that range between 0.25 per cent and 0.7 per cent. The plans, which are essentially a collection of personal pensions, are available through insurance companies, high street banks, investment organisations and employers and benefit from much reduced rates because pension providers are dealing with bulk business.
Roger Breedon, the principal of Mercer, says the reduced charges on GPPs can save individuals tens of thousands of pounds over the long term but stresses the importance of reading the small print. Many GPPs offer a facility known as an "active member discount" which offer favourable rates to members who contribute but which are subject to change once contributions stop.
"It means that if you stop contributing to the plan, then these annual charges can go up. So you might have had something that started looking quite competitive but then if you leave the plan, the charges could go up," he says.
Using an example of someone paying £200 per month for 30 years, a large scheme can negotiate a low annual management charge if cheap index tracking funds are used. At 0.25 per cent per annum, this would result in a fund of £220,000 assuming a 7 per cent per annum pre-charge investment return. This compares to a fund of £192,000 if the annual charge is 1 per cent.
Two of the countries ranked by Mercer as having the best private pension systems in the world are the Netherlands and Denmark. At least two major providers from these countries are set to bring their pensions to Britain.
Danish pensions giant ATP, which has an average annual management charge of 0.25 per cent, recently announced its plan to launch a pension product in the UK as early as this time next year. Morten Nilsson, the head of international operations at ATP, says: "The UK market is attractive because it's huge and we can't see many others trying to offer simple, cost-efficient products that perform. The low and middle income groups are not being served well today in the UK so I believe other pension funds will be looking at that as well." ATP says it can offer low charges because it pools cash from individual savers and employer schemes.
ATP will have its pensions in place by the end of 2011 and will be available to individuals and employers. Likewise, Dutch pension group AGP is looking to have a crack at Britain, again with the objective of undercutting many local providers on price.
Imagine a scenario where two 25-year-old men contribute £28,000 to two different pension schemes. Mr Smith saves into a pension fund charging a total of 1.75 per cent of assets in annual charges and Mr Jones saves into one charging 0.25 per cent. When they retire 40 years later, Mr Smith will receive a monthly pension of £589 or have a pot of £83,000, whereas Mr Jones will receive twice this amount with £1,186 a month or a sum of £149,000. This is how much the compounded effect of just 1.5 per cent extra in annual charges amounts to.
Tax free savings
For those who want complete flexibility and the chance to avoid high management charges, then a stocks and shares individual savings account (ISA) could be the best option. The products offer significant tax benefits, with profits made from share price increases not eligible for capital gains tax. What's more, up to £10,200 can be saved each year in an ISA, with up to half in cash and the remainder in stocks and shares. Money can be withdrawn at any time and switched to a different ISA offering a better return.
Bruce Jamieson, the managing director of Jamieson Financial Management, says ISAs are often better than traditional pensions.
"An ISA is much more flexible than a traditional pension, and you can leave it to your heirs. You haven't got any problems related to whether you are married to someone or in a same-sex relationship. None of that is problem as long as you've made a will."
Mr Jamieson calculates that an individual who saves £100 per month into M&G's Recovery Fund through a stocks and shares ISA could generate £14,100 after 10 years assuming a 5 per cent annual growth, £15,700 assuming 7 per cent growth and £17,500 assuming 9 per cent growth. This compares to just £12,000 if left in an account earning no interest.
Word of warning
Low charges aren't everything. While management charges can eat into a sizeable chunk of savings, investment performance also plays an enormous role in the eventual size of a pension pot. Other factors such as attitude to risk will influence you when deciding where to put your money. Mr Bamford of Informed Choice advises consumers to look at the bigger picture when making pensions decisions.
"People saving for retirement should always focus on value rather than price alone. If you exclude the cost of advice, pension plans are cheaper, but you run the risk of making poor investment decisions and losing far more in investment returns than you would have paid in advice charges."
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