26th August 2019
Welcome to Ireland’s award-winning Personal Finance Blog & Podcast. This week we explore a topic which is being asked more and more, what fees are payable, and what is the impact of these fees on a pension, with particular focus on Approved Retirement Fund (ARF). We will not just determine the impact monetarily but also the impact on how long that ARF might actually last you, which is kind of a big deal! This won’t be a long episode, but I sure hope it helps shed some light on a dark corner! If you haven’t already caught last weeks’ episode, which helps explain how to maximise the duration of your ARF, you can grab that here.
Now it goes without saying that you get nothing for nothing, and that we will pay fees in both the accumulation phase of pension/retirement planning, and in the spending-phase. Much like an egg-timer, where you turn it over, there is no halting it, there is a finite amount of grains in the top and there is a finite amount of time before they all pass through. We are precious of every grain, we only have so many to use. I guess in this case what we are trying to do is to be aware of any grains that might be escaping out the sides without us even knowing about it. We’re looking to plug any leaks!
The focus of this piece is very much on the impact of the fees on our ability to draw income from an Approved Retirement Fund over the course of our ‘Life 2’!
What Are The Fees On An ARF?
The Department of Social Protection conducted an extensive study of pension charges in Ireland and in 2012 released the monstrous ‘Report on Pension Charges in Ireland‘. It took these guys a 290 page report to outline all there is to know about the impact of fees, but here are the main ones that apply to traditional insurance-based pension contracts:
Interestingly, the analysis, which is obviously from 2012, showed that the fees for insured schemes were on average 40% dearer than those of non-insured schemes. However, for individual investors it only analysed ‘insured-schemes’, as there were no non-insured schemes really available to individual investors back in 2012 (there are now!).
Anyway, the heel of the hunt is that, despite what might be printed on the tin, the average all-in fees on a pension stood at 2.1%! This tallies with my own experiences, seeing all-in fees on insured schemes totaling from 1.7% to 3% generally.
This is in stark contract to the Pensions Authority who do relatively nothing to educate people on the real costs of their pension planning. On their website they state ‘In our example, a 1% annual management charge has the impact of reducing the fund built up over 20 years by over 10%’. This is only the tip of the iceberg, and in terms of educating people who trust them to watch out for them is a totally toothless attempt. They really should do better.
While I’m at it, I also would question the accuracy of the 2012 study. The reason being that insurance companies were only obliged as of 2018 to actually KNOW what the total fees were on the funds. And it took many a long time to figure that out! From 2018 they are obliged to disclose these fees if you invest in funds, but only for non-pension products. There, for some reason, remains no obligation to disclose to a client the all-in fees payable when you buy an insured pension.
The Financial Impact Of Fees
We all are probably aware of the impact of compounding, which has such a significant impact on the growth of long term investments. Your growth compounds on your growth. Way back in Blog #7 we explored and detailed how it’s power can be of help to us. This applies to the growth on your funds in accumulation phase but also in your spending phase, where our pot can remain logically invested over 2 or 3 or indeed 4 decades. It can be argued that fees will compound in accumulation but that as your pot is typically reducing in value in spending phase that that pattern will reduce with regards to both fees and potential growth, which stands to mathematical logic.
Having said that, how do fees reduce the long term value of an ARF. Taking our well-worn scenario of €1,000,000 pension pot, starting to draw an income from it at 60, hoping it will last you 30 years to 90. We are aiming big again, taking 4.5% from 60 to 70, 5.5% from 71 until we or the pot expire! We are not increasing our income in line with inflation in this scenario, in the interest of making this as clear as possible. We are invested in a 75/25 Equity/Bond portfolio with all-in fees of 2.1%, in line with the average figure the 2012 report determined.
With a 2.1% Fee
With a 1.1% Fee
So here everything else has remained the same, the only difference has been that we have fees of 1.1% instead of 2.1% on our ARF. These might not sound too dramatically different however I suggest otherwise. You can reasonably expect your pot to last 5 years longer, to 90. You can reasonably expect to be able to draw an additional €230k of income, and you can absolutely be entirely more confident that your strategy will work, which is the peace of mind that we all seek when it comes to our retirement income.
When we leave employment and move into our spending phase we all will want to protect each and every grain. It seems that many people are missing out on a significant portion of their accumulated grains, they have unnecessary leakage. Plug that leakage and you can achieve all of the above improved results.
We can achieve all of those positives simply by paying 1% less in fees. 1%, to many, might seem like a tiny grain of sand hardly worth checking or trying to do anything about. 1%, in reality could be difference between you running out of money in retirement, or not. That is surely worth our attention.
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