It's time to simplify charges surrounding pensions
The complicated terminology surrounding charges makes it hard for workers to assess if they are getting value for money. It is time these fees were made easier to understand, writes Fionan O'Sullivan
PENSION fees and charges have been a huge source of stress for many workers attempting to accumulate a reasonable nest-egg to see them though their retirement years.
There are two areas of contention -- the absolute cost of these charges and the complexity of them -- making it difficult for the average person to accurately assess whether they are getting value from the services they receive.
There are two principle types of pension. Defined benefit plans provide members with retirement and death benefits based on a percentage of the member's salary. Many plans aim to provide two-thirds of a member's basic salary after 40 years' pensionable service.
Defined contribution plans are more of a straightforward savings vehicle with no fixed guarantee. In simple terms, the more you put in, the more you get at retirement, whether it's part of a big employer scheme or a stand-alone arrangement.
Fees and charges are less of an issue with defined benefit schemes as they are invariably picked up by the employer.
In very broad terms, the following services are required in the operation of an employee benefit package: advice/consultancy; administration; investment management; and insurance of death-in-service and disability benefits (risk benefits).
A defined contribution scheme works by maintaining individual pension accounts for all participating employees.
The issues are: who manages the account; who pays for the advice; the underlying administration and investment management.
There are generally two approaches that may be taken by the company. Firstly, it can appoint an insurance company to act as administrators, risk insurer and investment managers under a group scheme (often referred to as an insured service package).
A deterrent to this approach in the recent past was the relatively poor level of service on offer. Thankfully, this situation is changing and there is a small selection of insurance companies that meet acceptable administration standards.
The typical charging structure where the adviser/broker is paid a fee for their services is as follows (commission arrangements are much more penal on net allocation and fund management charges):
- A bid/offer spread charge, typically 5pc of contributions, is deducted before the funds are invested. Most insurers have tried to move away from this and offer a net allocation which usually depends on overall scheme contributions and average contributions per member.
A good broker or adviser should be able to obtain 100pc net allocation.
- A policy fee that ranges from zero to €4.50 per member per month. The lower the contribution, the bigger effect this has in percentage terms.
- The Pension Board levy is being reduced from €9.50 per annum per member to €8.55 per annum per member.
- A fund management charge, which is usually 0.75pc a year (deducted from assets under management) but can be higher in some arrangements.
These charges can have a significant impact on performance. For example, a 50pc reduction in investment fees from 1pc to 0.5pc can add 17pc to the annual pension of a person who switches to the lower cost funds 40 years from retirement.
The key for those planning their pension is to establish what they are paying for and what they are getting in return.
These charges, with the exception of the fund management charge, are deducted from contributions unless alternative arrangements are made, ie the employer decides to carry these costs.
The broker is invariably paid separately by the client company for their advice role.
Alternatively, larger schemes can opt for the unbundled approach, which gives greater control to the company, trustees and members in various areas.
The principle difference between this and the insurance company package is that the client/trustees can select different insurance companies /investment managers for different services.
A typical charging structure for members is as follows:
- No entry deduction from contributions -- 100pc invested.
- No policy fee.
- Fund management charge as low as 0.3pc a year.
- Pension Board levy paid separately by the client company.
All of the above assumes the adviser or broker gets paid a fee. If it is a commission-based arrangement, the net invested contributions and fund management charge will be higher.
There are other choices to be made. For example, decisions need to be made between passive and active funds and what costs are associated with both.
Active funds attract a much heftier fee and members need to establish if they are worth paying or would they be better placed to opt for a less expensive passive fund option.
The higher cost of the active fund management can have a significant impact on your overall fund balance at retirement, a factor often ignored or indeed misunderstood by members.
As you can see the terminology in pensions is a nightmare, particularly when it comes to describing charges.
Charges can and should be simplified. The standard PRSA (Personal Retirement Savings Account), for example, has a 5pc charge on any money paid in and a 1pc annual fee.
That's not cheap, but at least it's transparent.
- Fionan O'Sullivan, director, IFG Corporate Pensions