Consider yourself a premiership footballer, consider me your agent. I have just negotiated your contract.
You have some questions on what I’ll be doing for my money, how long I’d be taking a slice of your pay and what options you have to renegotiate my “cut” or even sack me.
END OF FANTASY
But you’re not a premiership footballer and I’m not your agent. For “your pay” read “your pension” for “my cut” read “your pension Provider’s charges”.
The charges we pay to DC providers are negotiable, we have the right to sack and replace our DC managers and it is possible to substantially improve our post retirement pay by ensuring that the charges on our own pension and on the pension plans that our companies sponsor, are kept to a minimum.
We as individuals, companies and trustees enter into negotiations with DC providers like lambs to the slaughter.
And so we have no motivation to negotiate the charge….. nor any basis for negotiation even if we can be bothered.
So, whether buying for ourselves, as trustees or as corporate purchasers, we grant and will continue to grant the providers of our DC pensions free rein to charge more or less what they want.
CHARGES ARE ABOUT THE ONLY FEATURE OF OUR PENSION PLAN DESIGN THAT WE CAN CONTROL.
The biggest differentiator between DC plans is not administration – administration has become a hygiene factor.
Nor is it in investment choice – default funds have now converged around passive lifestyle.
Nor is it in the “advice” given to members – Auto-Enrolment and the RDR will make the need for that kind of “advice” obsolescent.
The biggest differentiator is the charge levied by the Provider on our accumulating pension fund. AND WE CAN NEGOTIATE CHARGES.
For all the talk about investment education and the need for increased contributions, the issue of both the quantum and impact of the annual management charge has barely merited a mention.
And the main reason that Providers (primarily these days insurers but also fund managers), get away with uncompetitive charges is that there is little understanding of the impact of an annual management charge on retirement income (pay).
So how can you work out how an annual management charge will effect you?
If I asked you for a cheque for a £1000 to run your pension scheme this year, you would know immediately that this would take a dent out of your retirement pay (you’d have a lot less to save for starters). If on the other hand I told you that I was going to take 1% out of your £100,000 pension pot, you might intellectually understand this amounted to the same thing but I doubt you’d be quite as bothered.
I think you’d be more bothered if you knew what that 1% charge amounted to.
For someone saving a regular percentage of an averagely increasing salary – eg most of us – it amounts to about 10% of our retirement pay if we save for 20 years and about 20% if we save for 40 years.
As this is a blog, I’m not going to bore you with the calculations bur my friends have some pretty clever spreadsheets that allow you to play around with these numbers using all kinds of assumptions and these percentages fall in the middle of the range of outcomes.
Now a 1% pa charge is at the top end of what most company sponsored DC arrangements are currently paying and most companies can negotiate scheme specific charging. Sometimes you will see the annual management charge on a plan being set at what appears a pretty random amount (I saw one at 0.47% the other day). The reason these charges are so precise is because the Providers know precisely what their margins are and precisely what they need to charge to achieve them.
Turn this round if the difference between 0.47% and 0.48% is important to your Provider, you can be pretty sure it’s important to you. It would be quite useful to start from the bottom up and establish what impact a 0.01% charge would have on your retirement plan. It’s easy enough – over 20 years it has an impact of 0.1% on your retirement pay if you save for 20 years or 0.2% if you save for forty years.
Bankers refer to the impact of the value today of a 0.01% difference as PV01 (Present value of 0.01% change). So for a 45 year old looking to retire at 65 their DC PV01 is 0.1% and it’s 0.2% for a 25 year old.
The benchmark AMC on a corporate DC pension plan is nowadays 0.50%. What we mean by that is that the average AMC on currently established DC plans (without commission paid to advisers) is 0.50% or 50 bps. Look at the AMC you are paying to work out how far ahead or behind the curve you are.
Someone with 40 years to retirement has a DC PV01 of 0.2%, if that person is paying 1%pa rather 0.50%pa on their DC pension fund then the impact of the extra charge is 50x PV01 or 10%. That’s a pay-cut in retirement of 10%!
And if you are that person, do you know why? It may be that you’ve chosen to have specialised investment management, you may have chosen to have initial and ongoing advice paid for by your AMC, but most likely you are paying more than you should out of ignorance and because your employer or trustee has not the time or energy to renegotiate for you.
If you feel ignorant or ignored then you need to be asking questions of your company, your trustees or your adviser . Understanding your DC PV01 may give you the confidence and motivati0n. You may not be a mega-earning footballer but your pension charges can be just as damaging as a football agent’s fees!
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