You can have the best performing pension on the market, but if the charges are too high, you won’t make any money
Before the advent of stakeholder pensions the level of charges in personal pensions was relatively high. A typical list of charges would be along the lines of:
Bid/Offer Spread: 5% difference between the price of units bought and their selling price. This was effectively a loss of 5% on each and every contribution from the first regular payment to the last and even including single contributions. This meant the fund had to grow by a minimum of 5% simply to break even.
Annual Management Fee: This was the basic charge levied by the pension company and on average would range from 1% to 2% per year on the value of the fund.
Annual Fund Charge: This was the charge levied by the company running the chosen fund and would be in addition to the annual management fee above. This charge varies, but could be anything from 0.75% to 1.5% per year on the value of the fund.
Initial Units: These were special units bought within the first two to three years which were then held until maturity. They would have an additional charge, over and above the annual management fee, which would typically be a further 3% per year.
Policy Fee: This is a flat rate fee, usually in the region of £1.50 per month. While this is small, it is a flat rate charge, and therefore has a disproportionately larger effect on small premiums.
Switching Fee: This was levied in the event you wanted to switch funds within the pension.
Transfer Fee: This would be a back-end charge if you chose to transfer your fund to another provider.
A welcome change
When stakeholder pensions were introduced things started to change. Stakeholder plans were forced to operate within a 1% per year cap – Pension companies could levy whatever range of charges they wanted, but they had to total no more than 1% per year. Clearly this was a big change, and has had a dramatic effect on pensions. A two-tier system soon developed where a potential customer had the option of investing in an old-style pension, with all the associated charges, or a stakeholder scheme with a fraction of the charges. The threat was a significant loss of business for the traditional pension providers.
As a way of combating this, many pension providers revised their products and brought down the charges on their personal pensions to be broadly in line with stakeholder. This meant that not only did new pension business predominantly go to these providers, but there was also the ability to transfer clients out of the old style plans into the new charged contracts, thus reducing their ongoing charges and increasing growth potential.
While most pension providers have closed their old-style contracts and focused on more cost-effective plans, millions of people are still trapped in these expensive contracts.