How annual management charges can reduce pensions savings
Annual management charges can have a significant impact on the growth of investments if a pension scheme is set up on a commission basis, so employers may need some hard negotiations, says Matthew Craig
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- Employees face higher annual management charges (AMCs) for group pension schemes if an adviser involved in the plan is paid on a commission basis.
- Over a longer period, having a higher AMC will significantly reduce an employee’s eventual pension pot
- Employers should negotiate hard because AMCs well below 1% should be possible.
- They should also ensure advisers provide an ongoing service if an ongoing commission is paid.
- Advisers should justify any commission payments.
- The Financial Services Authority’s Retail Distribution Review in 2012 should restrict the use of commission as a means of remunerating advisers.
Article in full:
It is a truism of pensions that the higher the annual charges, the less is left in the pot for the retiree.This principle is clearly seen in contract-based group pensions, where members pay an annual management charge (AMC) to cover the investment and administration costs. The higher the AMC is, the greater the effect on the eventual pension, reducing members’ retirement income.
If AMCs are too high, they could even outweigh the benefits of a group pension scheme. In theory, employers can negotiate more favourable terms by virtue of their size than members could do individually, so a contract- based group plan should give employees a pension at a lower cost and on better terms than they could get on their own.
But if a scheme is set up on a commission basis, as much as 20% of the first year’s contributions could go to a middleman. To recoup this, the provider will usually charge a higher AMC, reducing the pension benefits members can accrue. The use of commission payments in this way looks likely to be phased out by the Financial Services Authority’s Retail Distribution Review in 2012, but until then, some insurance companies and financial advisers will continue to set up group plans on a commission basis.
Commission payments on contract-based DC pensions
Commission payments are generally found in the group pension market when contract-based defined contribution (DC) pensions are used. These are cheaper and easier to set up and run than trust-based schemes. In addition, the arrival of charge-capped stakeholder plans in 2001 simplified the charging structure of contract-based pensions. Brett Smith, senior wealth adviser at Towry Law, says: “Stakeholder pensions have a maximum AMC of 1.5% for the first 10 years, dropping to 1%. Typically, most group schemes have an AMC of not more than 1%.”
Smith says the market will offer a range of AMCs for group schemes depending on how attractive a plan looks to pension providers. The number of employees, salary levels, contribution rates, staff turnover and the industry involved are all factors in assessing the appeal of a group scheme for a pension provider. “Providers will have a matrix based on various factors and what they deem a good scheme will be offered on more competitive terms,” he adds.
This means the AMC could vary from 0.3- 0.4% for very attractive schemes to 0.6-0.75% for those that are not so attractive.
But AMCs are bumped up if an adviser takes commission for setting up a group arrangement. Smith says commissions of 20% of first-year contributions could raise AMCs to about 1%. So, for a scheme with annual contributions of £600,000, an adviser could earn commission of £120,000 for a few weeks’ work. But if an adviser or benefits consultant is operating on a fee basis, an employer might pay much less. “We do not believe commission is the right way to pay for any advice,” says Smith. “Advice should be paid for separately from the product, particularly in the group market.”
Impartiality of advisers affected
An employee benefit consultant, which did not want to be named, said advisers operating on a commission basis should not be considered independent because their impartiality is affected by how much commission different providers are willing to offer them.
If commission is paid, the impact of higher AMCs to recoup commission costs could be significant. Kevin Stratford, head of DC at Watson Wyatt, says: “Employers do not necessarily appreciate what is going on. Employees bear the costs and employers do not see it. A bigger AMC will significantly reduce the eventual amount in an employee’s pension pot. A provider may also levy penalties if a member tries to move to another provider, so it is not totally portable.”
Paying fees instead of commissions
As an alternative to an employer paying an upfront fee to cover the cost of setting up a group pension scheme, the AMCs could be increased incrementally to cover a properly negotiated fee for the services an adviser is providing, rather than a chunky commission that receives little scrutiny. “Employers should work out what an adviser is bringing to the table and they should be able to get fees well below 1%,” says Stratford
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