Charge of the life brigade

Hard disclosure means you see how much financial services cost you - but how do you ensure value for money?

IN THE past six months there has been much press coverage about hard disclosure, the new glasnost covering charges for financial services products. The idea has been to help consumers understand what they are paying for.

However, although the consumer now has more information, it is questionable whether this has resulted in any better understanding. Being told who gets paid what doesn't help determine whether or not you are getting value for money.

There are two types of charge you are likely to encounter when buying a savings and/ or a pension contract - percentage fees and fixed charges.

The percentage charge means the fee is levied as a percentage of your premium, or of the value of your fund. The advantage of this charging system is that if you are paying small premiums you will pay proportionally smaller charges. Its obvious disadvantage is that particularly in respect of fund management charges, you pay an increasingly larger charge in cash terms as your fund grows.

On the whole you should not expect percentage fees to increase in line with inflation. You should, however, be careful that if percentage charges are taken from income, the charge is not going to substantially reduce the income you thought you were going to receive.

The other type of fee is a fixed charge, and does not usually vary with the premium that is invested or the income that is taken. Normally these types of charges are levied for a specific action. The most common example is regular monthly policy fees on personal pensions. Fixed charges are normally levied to cover particular administrative costs. For example, the policy fee on a personal pension reflects the direct cost of setting up the policy.

Although in practice you may be told a particular charge is used for a specific administrative task, in reality it is hard to identify precisely which element of the fee is actually used for which process within a life office.

Fixed charges are often index- linked. Normally the link is with the Retail Price Index (RPI) so that the fees increase each year with inflation. You should be careful to check. Even if there is not an automatic increase in fixed charges, many life offices reserve the right to increase fees in line with RPI on a discretionary basis. If this is the case, you should check if the fees have been put up regularly in the past.

Fixed charges can have a damaging effect on small investments, and on any small income distributions paid to you. If you are not intending to invest large amounts, or the income you might expect to receive from a regular distribution is small, you should be cautious of any fixed fee .

Most savings and pension products are now unit-linked. This means that you buy units in underlying funds. How many units you get for your money is dictated by an allocation rate. Allocation rates normally vary with the amount you are investing, becoming more attractive the larger the investment. Some policies will also offer better allocation rates if the policy is for a longer period or if premiums are paid annually in advance.

In addition, a number of contracts charge "capital levies". These effectively represent an additional management charge, normally just for a predetermined initial period. These charges reflect the initial costs involved in setting up the contract.

If you choose to close, or, as it is known in the trade, "surrender", your policy in the early part of the contract, you will find that you are unlikely to recoup the premiums you originally invested. Given that much of the cost of running a policy is taken early on by the life companies, such early surrenders bear the full costs to the life office of establishing the contract. A formal quote will show you how long you must wait before you will get any positive value from early surrender of your policy, but as a general rule it normally takes six years before you see any real return.

The other category of charges is known as penalty fees. Typical examples include fees if you stop paying contributions early or if you choose to retire early. Although these are often perceived as unjust, it is important to remember that most financial product contracts are long-term and priced accordingly.

Consequently, if you want to alter the terms of the contract, you will be charged for it. The only way around this is to buy a policy at the outset which allows you to make changes. Such policies may be more expensive than a contract under which penalties are charged for changes.

In return for giving you advice, and for saving you many hours in completing and chasing the necessary paperwork, your independent financial adviser needs to be paid. In the past your IFA would normally have been paid a commission by the life office. Under the hard disclosure rules, you will be shown exactly how much commission is being paid to the IFA.

There are now a number of IFAs who, like solicitors, instead of taking commission will charge you a fee for reviewing and managing your financial investments. In return, the commission that would otherwise have been paid to the IFA will be used to enhance the value of your investments. In practice this means the charges are reduced.

Don't be frightened by charges. But do make sure that you understand what you are paying for. Try to get a number of comparative quotes for products offering similar flexibility and performance.

q Mark Hayes-Newington is marketing director of The Research Department.