UK Chancellor George Osborne’s recent announcement to cap investment and pension exit fees is a big step in the right direction towards tackling punitive investment and pension exit fees.
The response by some in the industry to Mr Osborne has been disappointing. Their default setting has been to use complicated jargon and financial smoke and mirrors to hide the fact that exit fees are still being charged. Whether you call them exit fees or ‘surrender charges’ it’s time for some clarity.
Exit fees are an addiction that the industry is better off without along with hidden fees through the investment process. Expats are particularly vulnerable. Here’s how it works.
It starts when you take out a pension or investment product. You incur annual product charges of 1% to 2% to cover an initial commission payment of 3% to 7% (sometimes more) which is paid at outset to the advisor who sold you the product. Typically this commission is not disclosed to the client. Now here is the icing on the cake: if you then want to withdraw or move your pension or investment product from this firm, there is an exit fee. In the UK that can be high – up to 40% of the pension funds value according to Pensions Minister Baroness Altmann. For expats it can be much higher!
Even for supposedly reputable advisors you can end up paying money to switch your savings elsewhere. So called surrender fees can be 6% to cover the advisors commission.
The issue was brought to a head by the UK’s pension freedoms last year which made 700,000 people eligible to switch out of their pension products and to shop around. The catch is they still face early exit fees. The Financial Conduct Authority (FCA) conducted an investigation and found that 670,000 customers facing early exit charges were aged 55 or over.
Exit charges can be a killer for a pension portfolio. When an investor chooses to change or cash out of a platform, it is usually because of the need for liquidity. How ironic it is to get hit with a massive fee, when you need your cash the most.
Secondly, these fees are hitting those that are 55 years of age and over. These investors are usually beyond their peak earning years, and many are already retired. This demographic, more than any other, deserves easy access to their cash to be able to navigate sudden health care issues that can arise and the care of loved ones without being unduly penalized by early exit fees.
Additionally, these exit fees deter investors from switching or acting on their position, and this collective lack of action has the effect of limiting competition in an industry that sorely needs it.
If proper research and inquiries are not done before signing on the dotted line for a pension scheme, investors can find themselves with charges of anything up to an egregious 40% of their investment if they decide to switch to another plan or cash out. This is a hefty price to pay for access to your own hard-earned money and life-savings.
Industry responses have been somewhat luke-warm to the proposal of the cap on fees by the government, and it’s no wonder. Exit fees have done an incredible job of making money for these firms with very little effort on their part. Like any addictive substance, this easy money will be a struggle for these firms to wean themselves off of.
The cap on fees announced by the government is a step in the right direction, but why stop there? Financial advisors should be required to be upfront and explicit about all of their fees, but particularly initial commissions received and early exit fees. There is absolutely no good reason for this to not be the case.
When asked direct questions about commissions and management fees, your advisor shouldn’t respond to you with vague mumbo jumbo. It’s a clear warning sign. You should always be aware of exactly what you are paying for and how much, and your advisor should be able to spell it out for you clearly and succinctly. And if you are not happy with the advice and service you should be able to move your investment or pension to another adviser without penalty.
Transparency is nothing for financial institutions to be afraid of as it instils trust in their firm and the financial industry as a whole. Greater trust sets the tone for financial firms to have better and more lasting relationships with their customers. Transparency is just good business, plain and simple.
The Treasury’s proposal for a cap on early exit fees is just one more step forward and the entire financial industry should embrace it.
David Pugh, Director, The Fry Group (Singapore).