Everywhere you turn at the moment, you see money-saving tips. But many of them involve making sacrifices and quite small sums of money. However, there is a tip that may save some people thousands of pounds, will have zero impact on their current lifestyle but will probably leave them much better off in the long run.
This win-win saving could lie hidden in your pension fees if you have an investment-based pension. (It won’t apply to a final salary pension scheme.)
If you have a self-invested personal pension (Sipp), making changes should be straightforward. If you are contributing to a workplace scheme, it is more complex but still worth understanding fees and options.
It is one of the key themes of a new book by myself and Robin Powell, How to Fund the Life You Want. A refrain we come back to again and again is “only focus on what you can control”. You can’t control inflation, you can’t control the markets and you certainly can’t control who is prime minister. But many of us can reduce the fees we pay to have our pension managed.
If your money is invested, you’re almost certainly paying fees
Many people don’t notice their pension fees. They are invisibly deducted and never touch your bank account. But if you have an investment-based pension plan (“defined contribution” in the jargon), including any kind of workplace or stakeholder pension, money managers will always be somewhere in the mix.
They have multiple ways of extracting fees.
Investing must be done through a transaction platform, so you pay platform charges. These can vary between next to nothing and an annual 0.45% of the amount invested.
Your money gets invested in funds – that is, packages of shares in companies, bonds or commodities. So you pay fund management charges as well. Again, these can start at zero. But the most expensive can drain about 4% of your investment value each year.
Every time a trade is made on your behalf, you pay a transaction cost. The more frequently your money is traded, the more these will add up. Averages aren’t meaningful here but remember that for frequent trades across many funds, the sky’s the limit.
If you retain a financial adviser in charge of all this activity, it’s a bit like having a personal shopper: you are going to pay their fees on top. The most recent Financial Conduct Authority figures tell us that the average financial adviser charges 1.9% to cover their own fees alongside the platform and fund fees.
Active funds cost you more, and may do worse
Our book quotes the overwhelming evidence that “active” funds are not only a lot more expensive than “passive” funds but often do worse.
Active fund managers handpick your stocks. This is labour-intensive work, based on lots of research. And they spend a lot on marketing to promote their stated aim: beating the market average.
Unfortunately, the definition of averages means that for every fund that beats the market another must underperform. And the evidence shows that over the long term, the majority of active funds underperform.
One 10-year study from Bayes Business School concluded that fund managers’ stock-picking skills were cancelled out by their attempts to time the market, and by their fees. Better performance by a (tiny) pool of successful active managers was all eaten up by higher fees. None of it reached customers.
Adding insult to injury, active fees can be anything from two to six times more expensive than the alternative: index, or passive, funds. These inexpensive funds lock you into the market average. When a market rises, they rise. When it falls, your investments fall, too. This doesn’t sound great, until you realise that despite their fluctuations, over the long term, markets have always risen.
View image in fullscreenLook more closely at your pension scheme because you could save money. Photograph: Ridofranz/Getty Images/iStockphoto
A long-term market average can be a very good result to settle for, especially with much lower fees. Even a tiny difference in fees can generate a large gain, over the lifetime of investing that your pension requires.
Could you save thousands?
So let’s tot all this up for people retiring with investment-based pensions. In the latest Office for National Statistics survey, the median pension pot for people aged 55–64 was £107,300.
I calculated the charges for investing this pension in global bonds (20%), “value” companies (50%), and smaller companies (30%).
Then I looked at two contrasting approaches: a passive portfolio managed through the investment firm Vanguard, or active funds from the Hargreaves Lansdown platform.
I assumed no buying or selling for one year, so no transaction charges.
I found that Vanguard would charge £329 but that going active through Hargreaves Lansdown would cost £1,161.
Suppose you use an adviser to manage your money instead. The average adviser will charge 1.9%, or £2,039, for the pot above – £1,710 more than the DIY approach using passive funds from Vanguard.
For a £200,000 pot, the Vanguard saving would rise to £3,180 a year.
How to go about reducing fees
Pension fees are notoriously hard to unpick.
Ask your pension provider to itemise the first three expense categories highlighted previously. If you have a financial adviser, expect them to itemise costs for all four categories.
Vanguard is a good example but you need to find the cheaper platform and funds that are right for you.
A good target is 0.33% for combined platform and fund fees
For platform comparisons, we recommend Monevator. It is frequently updated, free and comprehensive.
A good target is 0.33% for combined platform and fund fees. If your provider can’t get close to that, seriously consider moving your pension.
What if you are paying into a workplace pension scheme set up by your employer? First, it’s worth finding out what fees your administrators pay and whether they are competitive. Second, understand your options. You may be able to move out of active funds and into passive funds charging lower fees. And if you contributed to more than one workplace scheme over your career, should you consolidate to the one with the lowest fees? This is a complex area. You may need one-off financial advice. But even if you decide you shouldn’t move, you can at least press your scheme’s managers about fees.
As you can see, just one year’s savings could amount to thousands, and you won’t have to forgo a single latte. Over 20, 30 or 50 years, the difference to your pension will be, to borrow the words of a recent chancellor, “eye-watering”.
Jonathan Hollow previously worked for the UK government’s Money and Pensions Service. He is a co-author with Robin Powell of How to Fund the Life You Want, published by Bloomsbury Business.