There is currently no standard method for calculating pension charges in the market, Ronnie Morgan, strategic market insight manager of Scottish Life, points out.
If the market is to function efficiently, Mr Morgan says the industry should be adopting a methodology that is consistent across all providers. He says Scottish Life supports a total expense ratio approach where the costs are strictly prescribed and the calculations monitored.
However, Mr Morgan notes TER does not capture the impact of expenses borne by the pension fund by transaction in the underlying investments (dealers spreads and commissions, for example)
These transactional costs can be highly variable but Mr Morgan says they can be calculated and disclosed, albeit retrospectively, in the interests of full transparency.
The calculation of charges is a vexed issue, according to Tom McPhail, head of pensions research of Bristol-based Hargreaves Lansdown. Details of what should be included in assessing pension charges and what should not is not easy to define.
The government’s cap applies only to administration fees borne by the member, and not, for example, trading costs. It also does not stop providers levying separate fees, such as that imposed in the wake of the cap by Standard Life.
Mr McPhail says: “Charges should be a consideration but once you get below 1 per cent, any further reduction in charges has a diminishing impact.
“It is therefore important not to get so hung up on the charges that it obscures other more important issues such as member engagement, higher contributions and good investment choices.
“The reduction in yield concept worked well. I think the key is to show investors how their charges compare with market averages so they can see relatively how much they are paying.”
Given the competitiveness of charges on new pensions today, Mr McPhail says there are other factors such as good administration and investment performance which should probably take precedence when contemplating switching.
He says the exception is the old pensions of 20 years ago, which are so expensive that it would probably in most instances make sense to transfer.
Even moderately high charges can have a significant impact on people’s pension savings over their lifetime, Morten Nilsson, chief executive of Now Pensions, warns.
Data from the DWP shows that over a 46-year period of saving, an individual paying an annual management charge (AMC) of 0.5 per cent would lose 13 per cent of their pension pot to charges. In contrast somebody paying a 1 per cent AMC would lose 24 per cent.
But even with pension charges, Andrew Tully, pensions technical director of MGM Advantage, says one-size does not necessarily fit all.
He says the impact of different charges will vary, depending on how much someone pays into a scheme, how long for and if they stop or start during that period.
“For example, someone with five years to retirement may be worse off with a scheme which makes a charge for each contribution and a yearly charge, rather than simply a yearly charge. Someone who pays in for 40 years may be better off with the dual charge.”
Mr Tully says it is vital for advisers to consider how much is paid into a pension scheme and how long those payments are made. Investment performance also has a major impact, he adds.
Mr Tully says: “A small change in the amount paid in, or the investment return achieved, can easily outweigh a small difference in charges.”
For the average fund size a charge based on assets under management seems fair, according to Saq Hussain, head of PricewaterhouseCoopers defined contribution consulting team in the north.
However, Mr Hussain says advisers should be aware as pot sizes grow (and they will quickly) there could be benefit in splitting out the administration cost and paying that as a fixed amount and paying an investment fee based on a fund management charge.
He says this approach could be ‘cleaner’ and mean lower charges compared to the current annual management charge model.
Mr Hussain says: “It could also be argued as ‘fairer’ as the ‘one size fits all’ model of a percentage charge means that there is a level of cross subsidy in the majority of schemes.”
