An annual management charge of 0.5% on personal accounts could produce borrowing costs of up to £4.5bn and could take almost 30 years to repay, warns the Pensions Policy Institute (PPI).
In its 41-page report: ‘Charging Structures for Personal Accounts’, the PPI analyses five possible charging structures for the new system, although it points out “no single charging structure, or combination of charging structures, has all of the desirable attributes” to meet the government’s five key criteria.
In the pensions white paper - Personal accounts: a new way to save’- the government suggested any possible charging structure should be evaluated to see if it:
- is fair to all members by taking into account their ability to pay;
- is simple and easy to understand;
- incentivises members to reduce costs and operators to maximise funds;
- and provides significant revenue in the early years of operation, reducing the amount of operating and financing costs.
However, the PPI points out in its paper each charge structure “has advantages and disadvantages and there are trade-offs that have to be made”, as for example the AMC only option disadvantages those who start saving early but then stop contributing, as the AMC is continually paid even if there are no extra contributions.
The five potential charging structures examined by the PPI, including the charging levels used in the organisations modelling to make the comparison fair, are:
- An AMC: This is a charge of 0.5% paid annually as a proportion of an individual’s funds under management
- A joining charge and an AMC: A joining charge – equal to three months contributions - is a one-off payment made by a member on his or her initial entry to the scheme. Since it is unlikely to raise sufficient revenue by itself to finance personal accounts, it could be combined with an AMC of around 0.45%.
- An annual flat fee: A flat amount – of £70 – which is the same for all individuals and paid annually for as long as the individual is a member of the scheme.
- A contribution charge: A proportion of each contribution - 10% - paid from the individual, the employer and the state.
- A contribution charge and an AMC: This is an example of a possible hybrid structure and combines a contribution charge of 5% with an AMC of 0.25%.
However, in its conclusion to the report the PPI points out depending on the main priority for the charging structure, different options could be chosen.
On the issue of fairness it points out it would depend on the definition used as, if it meant everybody should pay the cost of running their fund, this might suggest an annual flat fee is best.
But the PPI adds if it meant everybody should lose the same proportion of their fund to charges then a contribution charge may be appropriate.
The organisation says while none of the charging options would seem to directly incentivise members to reduce costs providers incur on their behalf, it says some of the options may encourage participation more than others, as for example, an up-front joining charge may discourage members.
In addition, it warns while an AMC may provide scheme operators with the greatest incentive to maximise fund value, other options such as the contribution structure may cause operators to place more focus on persuading people to contribute more to increase revenues than on improving investment returns.
If the government is most interested in reducing financing costs, the PPI suggests a hybrid structure of a joining charge and an AMC would be best as there would be no borrowing after 2012, compared to the most expensive option of an AMC only structure which could cost between £1.7bn -£4.5bn depending on the cost of capital, and which could take between 15-28 years to repay.
The financing of the different charging structures - PPI
|Charging option||Payback period||Peak amount of borrowing (£m, 2006/7earnings)||Total cost of capital (£m, 2006/7 earnings)|
|AMC||15 to 28 years||£1,700 to £4,500||£900 to £11,800|
|Joining charge + AMC||No borrowing required after 2012|
|Annual flat fee||2 to 3 years||£700 to £800||£100 to £200|
|Contribution charge||2 years||£600||£0 to £100|
|Contribution charge + AMC||5 to 6 years||£900 to £1,000||£100 to £500|
Niki Cleal, director of the PPI, says until now an AMC has often been used to illustrate the potential level of charges for personal accounts, as it has the advantage it can be directly compared to existing long-term saving and pension products such as stakeholder pensions.
However, she warns an AMC would also require a large amount of borrowing by the provider of personal accounts, while other fee structures, which would bring in more revenue from day one, would reduce the need for borrowing but could ultimately mean a lower overall cost to personal account members.
And she says: “Overall our analysis shows the charging structure in personal accounts is important but no single charging structure, or combination of charging structures that the PPI analysed, meets all of the government’s criteria. Each structure has advantages and disadvantages and there are trade-offs that have to be made.”
Instead, Cleal points out: “Ultimately, it is important to understand how consumers might respond to the different charging structures. The government may want to conduct further research to better understand how alternative charging structures may influence participation in the personal account scheme.”
Have your say: IFA Michael Riley says:
"Is it just me, or are the charges slowly starting to look rather not dissimilar to some personal pensions in the market, on a nil commission basis?"
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7034 2681 or email [email protected]IFAonline
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