Despite a trend in recent years for pension charges to be reduced the costs associated with retirement savings can range significantly, pension experts warn.
In the past there were a large number of different charge types. Ronnie Morgan, strategic market insight manager of Scottish Life, says the main charges were:
• member charges, paid as a set monthly fee;
• contribution charges, sometimes paid in the form of reduced allocation where not all of each contribution paid was invested for the member;
• bid/offer spread, the difference between the price the investor buys units in a fund and the price they get when the units are sold; and
• annual management charge levied on the accumulated assets of the member.
Often Mr Morgan says these charges were combined, making the overall cost of a pension difficult to ascertain.
Morten Nilsson, chief executive of Now Pensions, says when looking at a plan that was taken out 20 years ago, advisers should be trying to spot and calculate the following charges:
1) Bid/offer spread
2) Initial unit charge
3) Accumulation unit charge
4) Separate policy charge
5) Early encashment penalties
6) Separate transfer penalties
7) Charges for switching funds
8) Market value adjusters
9) Hidden investment charges outside of the annual management charge (covered by the total expense ratio)
In terms of market averages, when stakeholder pensions were introduced in 2001, Mr Nilsson says it is important to note charges were capped at an annual management charge of 1 per cent, although this was subsequently increased to 1.5 per cent for the first 10 years.
Many providers took advantage of the increase, although Mr Nilsson says the 1 per cent charge did become something of a benchmark. Since then, he says there has been downward pressure on charges, although some of providers have reduced the quality of the investment proposition.
The advent of automatic enrolment has maintained the pressure on charges and the simplification of those charges, Mr Nilsson points out.
At the lowest level, for large single employer group pension schemes Tom McPhail, head of pensions research of Bristol-based Hargreaves Lansdown, says charges might be just 0.3 per cent today.
For the government’s default auto-enrolment scheme, Nest, scheme charges are equivalent to around 0.5 per cent over a ‘saving lifetime’, which Mr McPhail said “is also a typical level for a good value DC scheme”.
Exact charges are more complicated for scheme like Nest, which levies an initial contribution charge (1.8 per cent) in addition to the AMC (0.3 per cent).
For smaller employers with lower paid employees, Mr McPhail says a charge of 0.7 per cent to 1 per cent might be typical.
Charge cap from April 2015
Earlier this month the government confirmed it was going to cap charges on occupational pensions at 0.75 per cent, to include all standard charges including initial contribution fees but not trading costs.
According to government calculations, Nest for example falls well within these thresholds.
Mr McPhail says it is very rare to come across a new scheme today with charges in excess of 1 per cent, however there are existing schemes with higher charges and one still occasionally comes across old individual arrangements with charges as high as 2 per cent a year or more.
Schemes will not qualify under automatic enrolment rules if they charge more than the government cap after April 2015 and thus an employer would have to use a different scheme or an additional default scheme if the provider does not reduce charges.
In response to the changes, Standard Life said it would introduce a £100 monthly member charge for smaller employers with modest contributions. The charge will apply to employers that previously agreed charges above the new cap with fewer than 50 employees and less than £150pm in average contributions.
Picking apart charges
When it comes to picking apart the charges Andrew Tully, pensions technical director of MGM Advantage, says schemes which have been set up in the last 10 years are likely to be either a simple percentage or a combination of a contribution charge and a lower ongoing charge.
According to Mr Tully the newer large workplace schemes such as Nest are more likely to have the combination charge, while providers generally operate a single charge.
Mr Tully says charges have been falling steadily and the Office of Fair Trading (OFT) found the average charge on new schemes written each year has fallen from 0.79 per cent in 2001 to 0.51 per cent in 2012.
However Mr Tully says there are still some legacy schemes that may have significantly higher charges. Many in the industry have welcomed the cap described above that will tackle these legacy charges, whilst calling for the cap to fall lower in future to 0.5 per cent.
Some schemes have members picking up all the charges (bundled schemes), Saq Hussain, head of PricewaterhouseCoopers defined contribution consulting team in the north, points out. Other schemes have members picking up only the investment charges while administration costs are met by the employer, usually known as unbundled.
In terms of a range of charges, Mr Hussain says on a bundled scheme he has seen charges of less than 0.2 per cent and in an unbundled scheme as low as 0.08 per cent.
As with all pension and investment funds, Mark Fawcett, chief investment officer of Nest, says advisers should note on top of headline charges there are often costs associated with buying and selling different types of investments, such as shares, bonds, property and so on.
These costs are known as trading or transaction costs, and can range from taxes such as stamp duty, to other things like brokerage costs.
Trading or transaction costs aren’t included in the annual management charge (AMC) or total expense ratio (TER) and rather than being expressed as a charge, Mr Fawcett warns they are sometimes referred to as a ‘drag on performance’.
As mentioned above, such trading costs were also not included under the government’s charge cap.
Mr Fawcett says these costs can affect the returns a member achieves on their investments and significantly impact the final outcomes for investors. The more transactions that occur, the greater the drag on performance.
Mr Fawcett says: “Transaction costs are not bad in themselves. In the same way you will pay stamp duty when buying a home, the stamp duty doesn’t mean you shouldn’t buy the property – it is still a good thing to do if you want to own your own home.
“The problem is when transactions occur with too much frequency and there is no improvement in overall performance to justify the extra trading.”
