We are routinely told to pay careful attention to the fees on financial products. But if the fees on your pension plan are only marginally more expensive than a rival product, it’s easy to assume this won’t make much difference to your standard of living in retirement – especially if a financial adviser keeps insisting that the more expensive plan should perform well enough to more than compensate for the impact of the fees you pay.
The truth, however, is that even small differences in charges will have a big cumulative effect, and you may be investing for several decades. As for the promise of higher returns, they all too often prove illusory.
Charges on pension products are so important that three years ago, the government took the unusual step of introducing price capping. Since April 2015, companies running pension schemes on behalf of employers have not been allowed to charge more than 0.75% of the assets in the scheme each year. That cap applies to administration and investment costs combined.
Many pension savers, however, will still be paying significantly more. The cap may not apply to savings you’ve built up with employers in the past if you left the pension scheme before April 2015.
And if you have a personal pension, such as a stakeholder plan or a self-invested personal pension (Sipp), the cap doesn’t apply either. The charges on these plans are often much higher, particularly when you take into account both the plan provider’s administration costs and the charges on the investment funds you have chosen to contribute to.
The effect can be dramatic. The government introduced the workplace pension charging cap after its research found a 1.5% annual charge would reduce the size of a pension fund by 34% over a working life, whereas a 0.5% charge would only reduce it by 13%.
Even much smaller differences than this can seriously affect your wealth. A study published last year by adviser Profile Pensions, based on research into 13,000 savers’ pensions, found that the average 45-to-55 year-old was paying 1.13% a year for their plan, while half the savers were paying more than 1.25%.
The typical fund in this study, worth £25,422, would increase to £51,878 after 15 years, assuming it delivered annual investment growth of 6% and continued to levy the average charge. By contrast, a fund with a 1.25% charge would be worth £50,994 after 15 years – almost £1,000 less.
So if you have legacy pension plans with uncompetitive fees, transferring your money into lower-cost alternatives could save you a packet. In this example, transferring the £25,422 fund into a plan meeting the government’s 0.75% cap would see it grow to £54,770 over the subsequent 15 years, assuming it achieved the same 6% annual growth. That’s almost £3,000 more than the average fund in the study would achieve.
Finally, if an adviser recommends a more expensive fund with the potential to outperform your current one, be extremely sceptical. For the higher-charging fund in this example to beat its price-cap-compliant rival, it would need to deliver annual performance every single year that was at least 0.4 percentage points better. That’s a brave bet.