Income plans hit by fees

ARTICLES in previous weeks have discussed the choices available to investors who want to take the benefits from their personal pension contracts - namely whether to buy an annuity now or take cash from the contract and buy an annuity later.

Now very little is for free in this world. And life companies and life salesmen in Britain charge investors for the contracts and services provided. So what will it cost investors to take the benefits from their personal pension contracts?

Under the disclosure requirements of the Financial Services Act drawn up by the Securities and Investments Board (SIB) and the Personal Investment Authority (PIA), life companies must inform investors of their charges on contracts and the reductions in the ultimate benefits received from making these charges.

Intermediaries, whether independent or company representatives, must also disclose to their clients the remuneration received (usually in the form of commission) for selling a particular product.

However, investors ought to have a general idea of the format of charges being made by life companies and the remuneration received by intermediaries when considering these choices on personal pensions ahead of being officially informed under the SIB/PIA requirements.

Buying the annuity

The charges levied by life companies, which are leaders in the annuity market, on annuity contracts are comparatively low compared with charges on single-premium life and pension contracts.

Charging formats do vary between life companies, however. One company makes a direct charge of around 3 per cent of the amount invested, while another charges 1 per cent of the amount invested with another 1 per cent taken off the annuity payment to cover the cost of paying the annuity. This compares with charges on single-premium personal pension contracts in the 6-8 per cent range.

These charges are lower primarily because commission rates paid to intermediaries are somewhat lower, 1 to 1.5 per cent of the amount invested compared with over 5 per cent of the premium on single-premium personal pension contracts.

Taking income

To date very few life companies have actually launched their income withdrawal facility, so the only details on charges that are available relate to these companies.

The charging structure can be split into two parts. These are:

q The cost to the life company of handling the income payments, managing the underlying investment funds and dealing with the administration.

q Payment of commission or other form of remuneration to the intermediary.

Some charges made by the life company will be fixed in money terms, while others will be a percentage of the premium or cash sum paid to the life company. Charges on the investment funds are a percentage of the value of the fund, so as the fund increases in value each year, so the charges rise in money terms.

Investors using the withdrawal facility need expert advice on both the amount of income to take out each year and the investment of the remaining funds.

As such, the work pattern is tailor-made for the adviser to be remunerated by fees based on the amount of work done.

If advisers are remunerated by fees, then the life company has only to charge for its expenses. The charging structure from Winterthur Life, one of the first life companies in this new area, is structured for a fee-based remuneration of advisers.

However, most investors in life and pension contracts are still reluctant to pay fees, and accept the commission system of remunerating advisers even though it could well cost them more.

All indications are that the income withdrawal facility will be used primarily by high and medium net-worth investors, at least initially, and for these investors fees are probably cheaper than commission. Still, as long as investors know and understand the different systems of remunerating advisers, the choice is theirs.

So commission is still likely to be the method of remunerating most intermediaries, and National Mutual Life has structured its charging format on a commission- based system of remuneration. As such it is com- plicated with several layers of charges.

However, most investors are not interested in the structure and level of charges as such, but what effect they will have on the benefits they receive. The general effect of charges should be assessed from the illustration that accompanies the product details. These can be complicated, however, and investors need to ensure that their advisers provide a full explanation of the charges and their effects.