Pension fees explained: what are you really paying?

Pension charges can appear deceptively simple.

You may see an annual management charge of 0.5%, 0.75% or 1% and assume that represents the total cost of looking after your retirement savings. In practice, several different charges may be deducted at different levels.

These can include the pension provider’s charge, investment fund costs, platform fees, financial advice, discretionary investment management, trading expenses and charges for accessing or transferring your pension.

Individually, each cost may appear relatively modest. Together, however, they can have a significant effect on the amount available to you in retirement.

That does not mean the cheapest pension is automatically the best. A higher-cost service may provide valuable financial planning, tax advice, investment management and ongoing support. The important question is whether you understand the total cost and receive sufficient value in return.

Why pension charges matter

Pension fees reduce the return earned on your money.

Suppose two pensions hold similar investments and produce the same return before charges. If one costs 0.75% a year and the other costs 1.75%, the lower-cost arrangement will retain an additional 1% of the pension’s value each year.

That difference is not limited to the charge deducted in the first year. Money removed in fees can no longer remain invested and generate future returns. Over a long period, this compounding effect can become substantial.

For a pension worth £500,000, a 1% difference represents £5,000 in the first year alone. The monetary cost may then rise if the pension grows.

Charges can be particularly important when: you have a large pension; retirement is still many years away; you are taking regular withdrawals; expected investment returns are modest; your pension contains several layers of fees; or you are paying for services you no longer receive or need.

The objective should not be to eliminate every fee. It should be to avoid unnecessary costs while retaining the services and investment approach that are appropriate for you.

How to Calculate Your Total Pension Costs

When reviewing a pension, ask for the total cost in both percentage and monetary terms.

A statement showing that your pension costs 1.4% a year may still feel abstract. Seeing that the same charge represents £7,000 a year on a £500,000 pension makes it easier to evaluate.

The total should include every recurring cost associated with the pension, not merely the most prominent charge shown on the provider’s website or annual statement.

You should also ask whether the figure includes:

• pension administration;
• platform or custody;
• investment management;
• underlying fund charges;
• financial advice;
• transaction costs;
• discretionary fund management;
• foreign-exchange costs;
• VAT where applicable; and
• any fixed monetary fees.

Some of these charges are deducted directly from the pension account. Others are reflected in the price or performance of the underlying investment and may therefore be less obvious.

The main types of pension charges explained

The terminology differs between providers, but most pension costs fall into several broad categories.

Pension administration or product charges explained

This is the cost of operating the pension itself. It may cover maintaining your account, processing contributions and withdrawals, producing statements and tax documents, meeting regulatory administration requirements, providing online access, maintaining beneficiary records and offering customer support.

The charge may be calculated as a percentage of the value of your pension, a fixed monthly or annual amount, or a fee applied to each contribution. Some providers use a combination of fixed and percentage-based fees, while others apply a tiered structure where the percentage charged falls as the value of the pension increases.

A percentage fee may initially appear low but become expensive as the pension grows. Conversely, a fixed charge can represent a disproportionately high cost for a small pension.

A percentage fee may initially appear low but become expensive as the pension grows. Conversely, a fixed charge can represent a disproportionately high cost for a small pension

Platform or custody charges explained

A platform provides the infrastructure through which investments are held, bought and sold.

The platform charge may cover:

• custody of investments;
• account administration;
• collecting dividends and interest;
• fund dealing;
• reporting;
• online tools; and
• processing corporate actions.

Some providers combine the pension and platform charges into one fee. Others quote them separately.

Platforms may also apply different charging structures to funds, shares, investment trusts and exchange-traded funds. For example, fund holdings might attract a percentage fee while shares and investment trusts are subject to an annual monetary cap.

This can make one platform economical for a particular portfolio but relatively expensive for another.

Underlying fund charges explained

Most pensions invest in one or more funds. These funds have their own operating and investment-management costs.

You may see terms such as ongoing charges figure; annual management charge; total expense ratio; or fund management fee.

These costs are generally reflected in the fund’s value rather than appearing as a separate cash deduction from your pension account. They nevertheless reduce the investment return you receive.

Charges vary considerably according to the type of investment.

A simple index-tracking fund may have a relatively low ongoing charge. An actively managed fund, specialist strategy, property fund or alternative investment may cost considerably more.

Low cost is not the only consideration. An actively managed fund may justify a higher charge where it provides access to a specialist market, manages risk effectively or produces sufficiently strong performance after fees.

However, a higher-cost fund should be assessed against a suitable lower-cost alternative rather than accepted without scrutiny.

Financial advice charges explained

Financial advice is separate from the cost of the pension and its investments. An adviser may charge a fixed fee, an hourly rate, a percentage of the assets they advise on, an initial implementation fee or an ongoing annual fee. Some advisers use a combination of these charging methods.

FCA rules require adviser charges to be clear. An ongoing advice fee should only be charged where an ongoing service is being provided. This service might include regular financial reviews, retirement cash-flow planning, investment suitability assessments, tax-planning discussions, pension contribution and withdrawal advice, beneficiary and estate-planning reviews, and support when your circumstances or relevant legislation change.

It is reasonable to ask exactly what is included in the fee, how often you will receive the service and who is responsible for delivering it. Paying an ongoing advice fee without receiving regular and useful advice is unlikely to represent good value.

Discretionary investment-management fees explained

Where a discretionary investment manager makes day-to-day investment decisions on your behalf, a separate management fee may apply.

The manager will usually have authority to alter the portfolio without seeking your approval for every trade, provided decisions remain within the agreed mandate.

This service may include:

• portfolio construction;
• asset allocation;
• investment selection;
• ongoing monitoring;
• rebalancing;
• risk management; and
• reporting.

Sometimes the discretionary management fee includes platform or custody costs. In other cases, these are additional.

A managed portfolio may also invest in underlying funds carrying their own charges. It is therefore important to identify whether the quoted management fee is the complete cost or only one layer.

What are Model portfolio charges?

Some advisers use centrally managed model portfolios rather than constructing each client’s investments individually.

A model portfolio service may carry an additional fee for setting the asset allocation, selecting funds, monitoring the portfolio, and issuing rebalancing instructions.

The pension platform, adviser and underlying funds may all charge separately.

Model portfolios can provide consistent professional oversight, but investors should understand who is responsible for the investment decisions and how much each part of the arrangement costs.

Pension Transaction Costs Explained

Transaction costs arise when investments are bought or sold.

They can include:

• dealing commission;
• bid-offer spreads;
• stamp duty on applicable share purchases;
• market impact;
• settlement costs; and
• charges incurred within investment funds.

A portfolio with frequent trading may incur higher costs than a relatively stable portfolio, even where the stated annual management fee is the same.

Not all transaction costs are shown in the same way. Some are charged directly to your account, while others are incurred inside a fund and reflected in its performance.

Transaction costs are not necessarily evidence of poor value. Trading may be required to manage risk, respond to market changes or rebalance the portfolio. The relevant question is whether the level of activity is reasonable and contributes to the intended investment outcome.

Foreign-exchange charges explained

Foreign-exchange costs can be overlooked.

They may arise when overseas shares are bought or sold, when dividends are converted into sterling, when investments trade in another currency or withdrawals are made from assets denominated overseas.

A provider may apply a percentage margin to the exchange rate rather than showing a separate explicit fee.

For investors with substantial overseas holdings or frequent trading, these costs can become material.

Ask what foreign-exchange rate or margin is applied and whether less expensive dealing arrangements are available.

Entry, exit and transfer charges explained

Modern pensions do not always impose explicit entry or exit fees, but older arrangements may include initial charges, allocation rates below 100%, transfer penalties, surrender adjustments, exit fees, early-access penalties or market value reductions.

Older pensions may also include valuable guarantees, bonuses or protected benefits that could be lost on transfer. A high charge does not, by itself, mean that an old pension should be moved. The potential cost saving needs to be weighed carefully against any guarantees or benefits that would be surrendered.

Before transferring, establish the pension’s full transfer value and whether any penalties apply. You should also understand which guarantees or safeguarded benefits could be lost, the cost of the replacement pension, the investment options available and whether regulated financial advice is required.

What are Performance fees?

Some investment funds charge a performance fee when returns exceed a specified benchmark or target.

These fees may be more common in absolute-return funds, hedge-fund-style strategies, private-market investments and certain specialist portfolios.

A performance fee should be examined carefully.

Ask:

• what benchmark or hurdle must be exceeded;
• whether previous losses must be recovered first;
• how frequently the fee is calculated;
• whether the benchmark is appropriate;
• what percentage of the outperformance is retained; and
• whether the fund’s standard management fee is already relatively high.

A performance fee may align the manager with investors, but poorly designed arrangements can reward a manager for market movements rather than genuine skill.

VAT on pension and investment services

VAT treatment can vary according to the nature of the service and how it is provided.

Some charges may include VAT, while others may be exempt or treated differently. Advice, financial planning and discretionary investment management do not necessarily have identical VAT treatment.

Rather than assuming that 20% will automatically be added to every quoted charge, ask the provider:

• whether VAT applies;
• which parts of the service attract it;
• whether the quotation includes VAT; and
• what the final amount deducted from your pension will be.

The comparison should always be based on the amount you will actually pay.

Workplace pension charge caps

Default investment arrangements in qualifying defined contribution workplace pension schemes used for automatic enrolment are generally subject to a charge cap.

Where charges are calculated solely as a percentage of the member’s fund, the limit is normally 0.75% a year. Some costs, including certain transaction and performance-related costs, may fall outside the cap.

The cap does not mean every pension is limited to 0.75%.

It may not apply to personal pensions arranged outside automatic enrolment, self-invested personal pensions, investments selected outside the workplace default, financial advice fees, all underlying transaction costs, or every charge associated with retirement withdrawals.

Workplace schemes may also offer institutional pricing that is difficult to reproduce in an individual pension. This is one reason not to transfer a workplace pension solely for convenience without comparing the costs and benefits carefully.

What is a reasonable pension fee?

There is no single correct fee for every pension.

A simple workplace pension invested in a default fund cannot be compared directly with a personalised service including financial planning, discretionary investment management, tax advice and complex retirement withdrawals.

The total fee should be judged against:

• the complexity of your circumstances;
• the investments being used;
• the quality and frequency of advice;
• the amount of financial planning provided;
• investment performance after fees;
• service standards;
• access to your adviser;
• tax savings or planning benefits;
• risk management; and
• the alternatives available.

The FCA’s Consumer Duty requires firms to consider whether the overall price paid by customers is reasonable in relation to the benefits provided. Fair value is not simply the lowest possible price.

A higher fee may be reasonable where the service provides meaningful value. A low fee can still represent poor value if the pension is unsuitable, performs badly, offers inadequate support or prevents you from making appropriate decisions.

Why percentage fees deserve particular attention

Percentage-based fees rise automatically as your pension increases.

For example, an ongoing fee of 1% represents:

• £1,000 a year on £100,000;
• £5,000 a year on £500,000;
• £10,000 a year on £1 million; and
• £20,000 a year on £2 million.

The work required may not increase in direct proportion to the value of the pension.

Some providers reduce their percentage fee at higher asset levels. Others offer fixed or capped charges.

This does not mean percentage fees are necessarily inappropriate. They can be simple, predictable and aligned with changes in the portfolio’s value. However, clients with larger pensions should consider the monetary amount and ask whether the service justifies it.

Do not assess fees without considering performance

Fees should be reviewed alongside investment performance and risk.

A low-cost portfolio that consistently underperforms an appropriate benchmark after fees may not offer good value. Equally, a high-cost portfolio should not be justified merely by pointing to a short period of strong returns.

When reviewing performance, ask for:

• returns after all investment charges;
• results over several market cycles;
• comparison with an appropriate benchmark;
• performance relative to the agreed risk level;
• an explanation of significant underperformance;
• the effect of cash holdings; and
• confirmation of whether the figures include advice and platform charges.

Comparisons should be made on a like-for-like basis. A cautious portfolio should not be judged against an equity index without recognising the different level of risk.

FCA value assessments consider costs alongside investment performance and service quality, reflecting the fact that value cannot be measured by price alone.

Check for Duplicate Pension Charges

Layered arrangements can result in two or more firms charging for similar work. For example, an adviser may charge for investment oversight while a discretionary manager charges separately for portfolio management. A platform may also levy administration charges that are partly covered elsewhere, while a model portfolio or underlying multi-manager funds may introduce additional layers of management fees. In some cases, both an adviser and pension provider may offer planning tools or services that are not actually being used.

Each service may have a legitimate purpose, but it should be clear who is responsible for each aspect of managing your pension and investments. This includes setting your financial plan, assessing investment suitability, determining asset allocation, selecting investments, making changes to the portfolio, monitoring risk, reviewing retirement withdrawals and reporting on performance.

Where responsibilities overlap, ask what additional service or value each fee provides.

Watch for old and forgotten pensions

People who have changed jobs several times may hold a collection of older workplace and personal pensions.

Some may be competitively priced. Others may have complicated or relatively high charging structures.

The FCA has identified that older non-workplace pension products can have multiple charging components and may attract higher charges.

Reviewing old pensions can help identify high administration charges, expensive legacy funds, limited investment choices, policies with guarantees, exit penalties, missing beneficiary nominations, funds no longer aligned with your risk profile, and pensions that could potentially be consolidated.

Consolidation can make retirement planning easier, but it is not always the right answer. Valuable guarantees, protected pension ages or employer subsidies could be lost.

Questions to ask your pension provider or wealth manager

Request answers in writing wherever possible.

1. What was my complete pension cost during the last 12 months?
2. What was that cost in pounds as well as a percentage?
3. Does the figure include every product, platform, investment and advice charge?
4. What transaction and foreign-exchange costs were incurred?
5. Is VAT included?
6. Are there any entry, transfer, withdrawal or exit charges?
7. What ongoing service am I receiving for the advice fee?
8. Who makes the investment decisions?
9. Are any management responsibilities duplicated?
10. How have my investments performed after charges?
11. What benchmark is being used?
12. Are lower-cost versions of the same funds available?
13. Does the fee percentage reduce as my pension grows?
14. Is a fixed or capped fee available?
15. Would any guarantees or benefits be lost if I moved?
16. How will charges change when I begin taking retirement income?

MoneyHelper identifies fund charges, platform or administration costs, transaction charges and adviser fees as common components of pension costs.

Pension Drawdown Charges: What to Check Before Taking Income

Charges become particularly important when you begin taking income from a pension.

In drawdown, the pension remains invested while withdrawals are made. Its sustainability will depend on investment returns, inflation, the amount withdrawn, the timing of withdrawals, market volatility, tax, and total ongoing costs.

Fees reduce the return available to support future withdrawals. During periods of weak markets, the combination of charges and withdrawals may place additional pressure on the pension.

Before entering drawdown, ask for a projection showing:

• your expected income;
• the effect of inflation;
• all ongoing charges;
• assumptions for investment returns;
• the impact of poor early market performance; and
• how frequently the plan will be reviewed.

Projections are not guarantees, but they can show whether the proposed level of income appears realistic.

Should You Switch Pensions to Save Money?

Reducing unnecessary costs can be valuable, but transferring a pension can create other disadvantages.

You might lose guaranteed annuity rates, protected tax-free cash, a protected pension age, investment guarantees, loyalty bonuses, life assurance, employer contributions, institutional fund pricing, or access to particular retirement options.

There may also be transfer, advice and implementation costs.

Compare the likely long-term saving with the value of anything being surrendered. Where safeguarded benefits are involved, specialist regulated advice may be required.

How a Wealth Manager Can Help Reduce Pension Costs and Improve Value

A wealth manager’s value should not be judged only by whether they select funds that outperform the market.

Their work may include:

• defining retirement objectives;
• calculating how much income you can afford to take;
• coordinating pensions with ISAs and other investments;
• managing tax allowances;
• deciding which assets to draw from first;
• reviewing investment risk;
• planning for a spouse or other beneficiaries;
• preparing for market falls;
• adapting the plan after changes in your circumstances; and
• helping prevent costly emotional decisions.

These services can be valuable, particularly where the finances are substantial or complex.

However, they need to be delivered rather than simply listed in a brochure. Clients paying for ongoing advice should expect regular, personalised and documented support.

How to choose a pension or wealth-management provider

When comparing providers, look beyond the headline annual fee.

Ask each firm to show:

• the complete annual cost;
• the cost in pounds based on your pension value;
• which services are included;
• who will be your adviser;
• who will manage the investments;
• the proposed investment strategy;
• the underlying fund costs;
• historical performance after charges;
• how retirement income will be planned;
• how often you will receive a review; and
• what it would cost to leave.

Use the same pension value and service requirements for each comparison. Otherwise, apparently similar quotations may cover very different propositions.

Cost matters, but value matters more

Pension fees can have a substantial effect on retirement outcomes, particularly when they are paid over many years.

You should know what you are paying, why you are paying it and what you receive in return.

A low-cost pension may be entirely suitable for someone with straightforward needs who is comfortable making their own investment and retirement decisions. Someone with several pensions, significant investments, complicated tax affairs or uncertain retirement-income needs may benefit from a more comprehensive service.

The right question is not simply:

“How cheap is my pension?”

It is:

“After considering cost, performance, risk, planning and service, does my pension provide good value?”

Findawealthmanager.com helps individuals compare wealth managers, their services and charging structures. Our matching service is free to use and there is no obligation to proceed with any firm.