Annual management charges can be a significant burden for DC pension scheme members, and it can be difficult to get a full picture of what they include.
If you read nothing else, read this…
- Annual management charges (AMCs) can range from approximately 0.3% to 1%.
- Employers setting up a new pension scheme may be able to take advantage of competitive terms being offered by providers in a ‘land grab’ ahead of the Retail Distribution Review coming into effect from 1 January 2013.
- The make-up of AMCs will vary between schemes, but often they do not provide the full picture on fees and charges.
Annual management charges can be a significant burden for DC pension scheme members, and it can be difficult to get a full picture of what they include, says Nicola Sullivan
Pension scheme annual management charges (AMCs) have been thrust into the limelight as HR professionals conduct cost reviews, but there is a lot to understand about how the charges work.
A common assumption about AMCs, as applied to defined contribution (DC) schemes such as group personal pensions, is that they cover annual investment and administration costs. In fact, an AMC on a DC scheme will range from 0.3% to about 1% and covers the costs associated with investment, distribution, administration and technology platforms, as well as pension provider overheads. In some cases, commission that has been paid to advisers and consultants by the provider will be included in the AMC.
An AMC will also be determined by wider factors, such as staff turnover, the average age of scheme members, the use of active member discounts, fund values, and the number of pension transfers into the scheme. This makes it hard to assess value for money.
Catherine Cunningham, policy adviser at the National Association of Pension Funds, says: “One of the main difficulties in the disclosure of pension charges is lack of consistency. There are various definitions, and some do not capture all the charges. For example, a typical AMC might cover scheme governance, compliance and operational costs.”
Cunningham says HR professionals must be mindful of whether AMCs cover audit fees or fund administration costs.
Total expense ratio
According to James Biggs, head of corporate pensions – workplace savings at Lorica Employee Benefits, the total expense ratio (TER), which should be detailed in providers’ literature, is one of the most effective ways of identifying the real costs. The TER takes into account factors relating to the fund’s operating expenses, such as dealing costs, stamp duty and auditor’s fees, as well as the AMC.
Jamie Fiveash, director of customer solutions at B&CE, provider of The People’s Pension, says: “Ask what the TER is, because that is inclusive of more charges. There is some standardisation over what a TER is, whereas with an AMC there is no standardisation.”
To complicate matters further, extra charges relating to the use of unit trusts or self-invested personal pensions within a corporate wrap are more likely to crop up in the reduction of yield, which accounts for how investment growth is eroded by charges, rather than the TER, says Biggs.
Complex and highly managed funds will increase a scheme’s AMC, so fund selection should be balanced between individual fund fees and the potential value the fund could deliver to pension scheme members.
For its annual research on default funds, Calibrating DC outcomes: Three lenses on workplace savings, published last month, DCisions analysed the fees charged on funds provided by 24 asset managers,according to three categories – low-charging, medium-charging and high-charging – and then looked at the value the funds would have delivered over the last three years.
Nigel Aston, business development director at DCisions, says: “By value, we are looking at risk-adjusted return. In other words, for every unit of risk [the member] takes, how much return are they getting back?
“Typically, the low-charging funds are passive and fairly highly equity-driven. The mediumand high-charging funds are typically diversified growth funds or multi-asset funds, so they are less risk averse and have a smoothing effect. They take some of the bumps out of the market, but [the member] pays for that.”
The research concluded that the medium-charging funds gave better risk-adjusted return to the investor, and so offered best value for money. Aston adds: “Employers don’t want to go for the ultra-low funds because, over the last three years, it hasn’t been a comfortable place to be. Similarly, by paying high fees, you haven’t necessarily outperformed the medium fee-charging fund.”
Active member discounts
Employers can improve scheme terms by offering active member discounts, whereby charges are increased for pension scheme leavers. For example, an active member may be paying an AMC of 0.3%, which would soar to 0.6% if they left the scheme.
Lorica’s Biggs says: “Active member discounting is still pretty popular with employers. These discounts allows employers to reward loyalty, attract and retain, and give a bit of extra reward for people that are long-serving and those likely to be long-serving.”
However, active member discounting is not looked on favourably by The Pensions Regulator, which has said it is unfair, so the practice should be used with caution.
On the upside, the Retail Distribution Review (RDR), which will end the practice of remunerating corporate advisers and employee benefits consultants by commission paid by pension providers from 1 January 2013, could have a positive impact on AMCs.
The RDR changes mean pension providers will no longer be able to pay advisers commission for setting up contract-based DC schemes – a fee that is often built into employers’ AMCs. This could result in lower AMCs.
Jamie Jenkins, head of workplace strategy at Standard Life, says: “We don’t implicitly pay commission within the pension charge, but some providers still do and that could push the AMC above 1%. Commission is a big factor if it is charged within the AMC.”
The downside of this is that advisers are likely to start charging a consultancy fee for the services they provided when they were receiving commission, including financial advice, information and education.
To manage pension scheme costs, employers should take advantage of competitive terms being offered by providers ahead of the RDR, says Biggs. “A few of the mainstays in the commission market are still looking at ‘land grabs’. You have got really good terms being offered by Aviva and Aegon, and Scottish Windows can be added to that list.”
But irrespective of provider, employers should consider AMCs in the context of other fees that crop up in the TER to assess the competitiveness of a scheme’s charges.
What employers need to know about pension scheme charges
- Typically, an annual management charge (AMC) on a contract-based defined contribution pension scheme covers costs associated with investment, distribution, administration and technology platforms, provider overheads, and, in some cases, commission that has been paid to advisers and consultants by the pension provider.
- Employers can achieve better terms for employees by offering active member discounts, so charges are increased for leavers.
- The total expense ratio gives a more accurate picture of scheme charges. This takes account of factors relating to a fund’s operating expenses, such as dealing costs and auditor’s fees, plus the AMC.
- Employers need to strike a balance between fees and value when selecting funds.
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