Understanding fund charge rebates

As annual fund charge rebates become more common, so does the confusion they cause. Read on to find out all you need to know to be confident of getting a good deal..

One topic that seems to cause more than its fair share of confusion is annual fund charge rebates, especially when buying via fund platforms/supermarkets/wraps (or whatever else you want to call them) and discount brokers. Fortunately it's quite straightforward once you understand what's going on, so here's the rundown:

What's in an annual charge?

A typical 1.5% annual fund charge breaks down as follows:

• 0.5% - paid as a 'trail' sales commission to financial advisers.


• c0.25% - paid as a fee to the fund platform on which the fund is held.


• c0.75% - revenue pocketed by the fund provider.

Whereas trail commission is fairly standardised at 0.5%, the c0.25% paid to fund platforms is harder to determine - primarily because the amount doesn't have to be disclosed to customers. I wouldn't be surprised if some platforms take more than this, particularly on bigger selling funds that are promoted via 'recommended' or 'best buy' lists. While this isn't really your problem , it comes out of the fund provider's margin, it does potentially give reason to take such lists with a pinch of salt (is a fund included on merit or because it's more profitable for the platform?).

How do fund rebates work?

There are two sources of potential rebate: trail commission and the platform fee.

Trail commission rebates (either partial or full) are given by some discount brokers - FSA regulated companies that don't give advice, but simply transact investments and collect commissions. These rebates are usually paid to your bank account or the cash account on the platform you're using.

Platform fee rebates are given by a few platforms who instead charge an explicit fee to customers for their services - i.e. they rebate the fee received from fund providers (to your cash account) and charge you a fee instead. What matters is whether the fee you're charged is higher than the rebated platform fee.

In some cases (e.g. via the Nucleus and Aviva platforms) it's possible to buy 'institutional' versions of funds which don't pay commissions or platform fees, so a fund normally costing 1.5% a year will instead cost around 0.75%, although you'll expect to pay a platform fee in addition.

What about discount brokers who operate their own platform?

Discount brokers like Hargreaves Lansdown, Alliance Trust and Bestinvest who operate their own platforms ('Vantage', 'i.nvest' and 'Select' respectively) collect both the trail commission and platform fee, meaning they're often paid half or more of a fund's annual management charge. Obviously they have to foot the bill for running a platform, but it does potentially increase their overall profits and/or ability to offer rebates to customers.

Focus on the bottom line

There are quite a few permutations of the above, buying funds direct from platforms, on platforms but via discount brokers or advisers and from platforms operated by discount brokers.

This means rebates can vary from zilch to around half the annual management charge, but the key is to look at the bottom line, i.e. what you'll end up paying after all rebates and extra charges. I've taken a look at a selection of options below to see how they stack up.

The figures show typical rebates for a fund charging 1.5% a year (held within an ISA) and include estimates of the amount you'd save on a £50,000 investment over 10 years compared to the standard 1.5% charge (assuming 7% annual growth before charges) and the net amount (margin) pocketed by the provider after rebates and fees. I've assumed fund rebates simply offset the annual charge - not strictly true if it's rebated as cash, but fine for comparison.

Platform purchased direct

Provider	Fidelity Fundsnetwork
Annual rebate	Nil
Other annual fees	Nil
Your net annual cost	1.5%
Potential 10 year saving	Nil
Provider's estimated annual margin	0.75%

Buy direct from Fundsnetwork and they'll be laughing all the way to the bank!

Platform purchased via discount broker

Provider	Cavendish Online (using Cofunds)	Clubfinance (using Skandia)	Fairinvest (using Nucleus)
Annual rebate	0.5%	0.375%	0.75%
Other annual fees	£25 one-off charge	£68.50 Skandia charge	Fairinvest 0.5%
Your net annual cost	1% plus one-off £25	1.125% plus £68.50	1.6%
Potential 10 year saving	£4,090	£2,134	-£806
Provider's estimated annual margin	Cavendish Online £25 (one-off)	Cofunds 0.25% Clubfinance 0.125%	Fairinvest 0.5% Nucleus 0.35%

Cavendish Online's one-off £25 revenue is so small I can't see them becoming rich from selling ISAs, still, it means a great deal for customers. Clubfinance keeps a quarter of annual commission, but is still reasonable value despite Skandia's charges. Although Fairinvest offers the highest annual fund rebate, charges actually end up higher than normal after they and Nucleus have taken their fees.

Platform purchased via financial adviser (assumes 0.5% trail commission paid to adviser)

Provider	Aviva Wrap	Standard Life Wrap
Annual rebate	0.75%	0.5%
Other annual fees	0.25% Aviva charge 0.5% financial adviser	0.5% financial adviser
Your net annual cost	1.5%	1.5%
Potential 10 year saving	Nil	Nil
Provider's estimated annual margin	0.25%	0.25%

Aviva offers institutional fund pricing, but net costs return to the usual 1.5% after their platform charge and trail commission have been paid. Standard Life does thing slightly differently, but with the same end result.

Platform operated by discount broker

Provider	Alliance Trust Savings i.nvest	Bestinvest Select	Hargreaves Lansdown Vantage
Annual rebate	0.5%	0.25% (only on £50,000+)	0.25%
Other annual fees	£30 ISA fee	Nil	Nil
Your net annual cost	1% a year plus £30	1.25%	1.25%
Potential 10 year saving	£3,716	£2,046	£2,046
Provider's estimated annual margin	0.25% plus £30	0.5% (0.75% below £50,000)	0.5%

Alliance Trust Savings leads the pack by rebating all trail commission, although partially offset by their annual ISA fee. Bestinvest and Hargreaves Lansdown look a bit stingy by comparison, typically rebating half the trail commission, which leaves them raking in around 0.5% or more a year - a lot more than the cheapest discount brokers (even after the cost of running a platform).

Conclusion

Fund rebates are a good thing - they can save you lots of money. But while some providers claim to be giving you a great deal, they end up pocketing far more for themselves than they rebate to you. Always look at your actual cost net of any other charges, as this can vary widely (see examples above).

Read this article at http://www.candidmoney.com/articles/article233.aspx

Switch from Bestinvest Growth Portfolio?

Question
I discovered your site last year and I have been meaning to congratulate you on what I find to be an incredibly informative, knowledgeable and comprehensive financial site. Please keep the articles coming, especially those that give the inside view on financial advisers and products.

Your article on financial adviser funds was of particular interest to me, as I have ISA funds in Bestinvest's Growth Portfolio. Better value may be found if I switched to other funds. The problem is which ones to choose? I know that a spread of funds around the world is the right way to go and that time in a fund, rather than timing, is essential.

Comments on selecting an alternative way forward would be much appreciated, though I realise you cannot give individuals specific financial advice.Answer
Thanks for the kind words and glad you're enjoying the site.

The Bestinvest Growth Portfolio has total annual charges (as measured by the 'total expense ratio' - 'TER') of 2.33% - this includes Bestinvest's 1.5% annual fee plus underlying fund charges. If you invest more than £50,000 in the fund Bestinvest's annual fee falls to 1%, cutting the TER to 1.83%.

If you're paying 2.33% that's rather steep, although 1.83% is not unreasonable for a fund of funds. Either way, charges are likely to be higher than Bestinvest's standard investment advisory service, which provides 'free' advice on portfolios of £50,000+ in exchange for the fund trail commission (typically 0.5% a year), where TERs are likely to average around 1.6% or less. And the Bestinvest Managed Portfolio route is a lot more expensive than using a discount broker that rebates all trail commissions (like Cavendish Online), where the effective TER will be around 1% a year on typical managed funds.

However, charges are only half the picture, performance being the other. If a fund of funds manager performs well you might still end up better off overall versus doing the job yourself.

This is a harder to gauge, as the only real basis for guessing the future success or failure of a fund of funds manager is to look at the past, which isn't particularly reliable, and form an opinion on their current fund holdings - not easy.

If we look at Bestinvest Growth Portfolio fund manager Graham Frost's track record to date it's mixed, essentially one good year, one bad and one indifferent. His track record across all the Bestinvest Portfolio funds is reasonable and he scores a respectable 79.4% on Bestinvest's Manager Record Index (MRI) measure (which estimates the likelihood a manager has added value due to skill rather than luck). Nevertheless, Growth Portfolio performance is hardly anything to write home about.

If you're comfortable choosing your own funds then buying via the cheapest discount brokers (list in our guide to ISA discounts) might see you end up better off than staying put, but this will obviously depend on how skilful/lucky you are at choosing funds.

Alternatively you might try your luck with another fund of funds manager with a better long term track record, the Jupiter Merlin fund range springs to mind (although they're expensive with TERs of around 2.5%).

Or, you could stay with Bestinvest but consider moving across to their investment advisory service if you have more than £50,000 invested. This should reduce costs and, provided the service you receive is good, your portfolio shouldn't end up looking too different to the Bestinvest funds of funds.

Read this Q and A at http://www.candidmoney.com/questions/question496.aspx

How much do you need to save for a comfortable retirement?

It's common knowledge that as a nation we're not saving enough towards retirement. But how much do you need to save to retire comfortably?.

The answer obviously depends on what you'd class as comfortable. But for the purpose of illustration let's plump for £18,000 a year, about two thirds of average earnings.

Assuming you qualify for a full basic state pension, we can knock off about £5,000, meaning you'll need to provide £13,000 a year from somewhere when you retire.

If you're fortunate enough to have a final salary pension then it's quite easy to guesstimate how much pension income you'll get, just multiply your total years of service by the scheme's multiple (e.g. 1/60th) and then your estimated salary at retirement (some final salary schemes are a bit more complex, but this is the gist of how they work). So someone earning £30,000 at retirement with 26 year's service in a 1/60ths scheme would expect an inflation-linked pension of £13,000 a year.

However, this assumes that your final salary scheme remains open until you retire and that you remain in the same job - both far less likely these days than in the past.

For the rest of us things are more difficult to predict, as our retirement income will depend on investment performance and, if you save via a pension, annuity rates.

If we assume an annuity rate of 3.5% for a non-smoker in their mid sixties buying an inflation-linked pension with 50% spouse income (on death), then they'd need to have a pension fund of about £370,000 to produce a £13,000 annual income.

How much do you need to save each month to build up £370,000? Well, it depends on investment performance and how long you have until retirement. I've calculated some examples below assuming a 6% annual return after charges:

Years until retirement	Monthly saving required	Value of £370,000 at retirement if 3% inflation	Inflation-adjusted monthly saving required
40	£193	£109,414	£402
30	£378	£148,373	£638
20	£812	£201,204	£1,129
10	£2,266	£272,847	£2,647

The monthly saving required (left hand column) looks quite horrific. But this doesn't take inflation into account - our £13,000 income will buy less at retirement than it does today if prices continue to rise. Factor this in (so that the £13,000 at retirement is in today's terms) with assumed annual inflation of 3% and the required monthly saving (right hand column) is enough to make you weep.

The trouble with assumptions is that they could be wrong. Investment performance, annuity rates and inflation could all end up high or lower than the figures I've used (and, of course, you might choose to retire younger or older), but I don't think they're that unrealistic. The required saving would be lower if we assume a flat (rather than inflation-linked) pension, but I think inflation proofing your pension income is pretty key if you expect to live for a while.

Where does that leave us?

In reality, probably with far less money in our retirement pots than we'd like. Which begs the question, should you bother?

You might decide to live life to the full and, in the words of Roger Daltry, "hope I die before I get old". Trouble is, Mr Daltry is now nearing 70 and looks in fine fettle (albeit I doubt he has to worry about his pension)...

Otherwise I think the only viable approach (if you won't have a decent final salary pension) is to save what you can, invest wisely and hope it's enough. Whether you use a pension, ISA, property or some other route to save for retirement doesn't really matter, the key is that you save into something that's robust, cost effective and has the potential to perform well.

Nevertheless, it's a good idea to keep tabs on your retirement pot and have a feel for what it could be worth when you retire. You could try using our 'How much will I get' retirement calculator - just bear in mind it requires making assumptions (like my very simple examples above), so take the outcome with a pinch of salt.

Read this article at http://www.candidmoney.com/articles/article231.aspx

Question
Coming up to 65, I find that, due to a varied career, I have three personal pension pots estimated to be worth about, £5k, £20k, and £50k. The terms of the contracts appear to mean that, effectively, I cannot transfer these before retirement/maturity without possible penalties.

My questions are:

is it possible for me to transfer all three at maturity into one pot to achieve a better annuity rate or can each provider insist I apply for an annuity separately?

If the latter is the case, does the '25% tax free commutation' apply to each pot separately or can I, say, commute the £5k pot, leaving me with turning the two larger pots into annuities.

Or is there a third way I haven't thought of?

Many thanks.Answer
Annoying that you can't transfer without penalty - many older personal pensions levy nasty penalties if you want to move to another provider (in part because they paid enormous sales commissions at the outset which they recoup over the life of the pension).

Annuity providers tend to give lower rates on smaller sums, so using a single annuity provider makes sense - especially as you'll likely want to use whoever's offering the best rate at the time for all three pensions.

Annuity providers normally allow you to combine several pensions when buying an annuity, so this shouldn't be a problem.

Technically there are two ways this can happen. The three pensions can be transferred 'as is' at retirement into a pension with the chosen annuity provider, from which the 25% tax-free cash can be paid and an annuity purchased straight away - this is called an immediate vesting personal pension. Or, the 25% tax-free cash can be paid out by each existing pension provider and the balance sent to the annuity provider who'll combine all three into one annuity - called an 'open market option'.

Pension providers must offer you an open market option (i.e. the ability to buy your annuity from another provider) while a immediate vesting transfer might be viable provided your existing providers cease to penalise transfers at retirement.

Both routes will probably lead to a wait and some stress at retirement because insurance companies tend to be rather inefficient at administration, but it's small price to pay if you can bag a better deal on the income you'll receive for the rest of life.

The 25% tax-free cash must be applied to each pension separately, although if you consolidate it'll be 25% of the combined £75k pot.

Before buying an annuity with another provider just check you won't lose any benefits, such as a guaranteed annuity rate, with your existing provider. I suppose the only reason for keeping the pensions seperate (aside from possible loss of benefits) is that it gives you the flexibility to take each pension at a different time, although.chances are you'll want all the tax-free cash and income when you retire.

Read this Q and A at http://www.candidmoney.com/questions/question493.aspx

Time to sell Northern Rock PSNs?

Question
Can I sell PIBs?

Also I have some pibs with Northern Rock, are these only fit for the bin or will I ever have any interest on them again?Answer
Without wanting to sound facetious, you can sell PIBs provided someone else wants to buy them.

The reason I say this is that the PIBs market is quite small and there can be a shortage of buyers, meaning they may be difficult to sell, especially at a decent price. The simplest way to find out is to ask a stock broker; Collins Stewart seems to be prominent in the PIBs market, but most others should be able to tell you if there are potential buyers and, if so, give you a price.

Your Northern Rock PIBs (actually called 'Perpetual Subordinated Notes' - PSNs - since they converted to a bank) seem to be selling for around 46p at the time of writing and there does appear to be market for them, so it should be possible to sell.

No news yet on if/when Northern Rock will resume coupon (income) payments and it's anyone's guess on whether the PSNs will be purchased/.redeemed in future, so keeping hold of them is something of a lottery.

The future of your PSNs depends on the fortunes of Northern Rock Asset Management (NRAM), the part of Northern Rock that holds the 'toxic' debts.

Thanks in part to falling bad debts, NRAM has been doing well recently, posting a £277 million underlying profit in 2010 (although it lost £313 million the year before). If this sort of performance continues you might make money by holding onto your PSNs, but there are risks - e.g. bad debts and mis-selling claims (especially PPI) could rise (see my answer to an earlier question here). The advantage of selling now is avoiding further risk and being able to earn some interest on the money elsewhere.

Read this Q and A at http://www.candidmoney.com/questions/question492.aspx

Should I use absolute return funds?

Question
I am recently retired at 60 and my wife is not currently working but may do so part-time. We have enough cash for forecast spending in 2011-12 and for emergencies. We have about £100k in unit trusts put aside for the longer term (10 years plus) in a mixture of 30% gilt/linker funds and 70% equity (global/UK trackers plus active EM, resources and property funds).

We have another £100k to invest over 2-8 year timescale for university costs for the children and moving to a better house. I am thinking about putting this money into a mix of Trojan O, Ruffer Total Return O and Newton Real Return (and possibly Absolute Insight Ap) funds. Does this seem reasonable or unnecessarily risky over this time period?Answer
Your existing investment strategy looks very sound, so well done. If you haven't done so already I'd focus on getting the investments within ISAs for both of you to ensure a tax efficient income and avoid that income counting towards the limit for higher age-related income tax allowances (£24,000 for 2011/12 tax year - may or may not be a problem depending on how much pension income you both receive).

As for your new investments, a focus on absolute return does, in theory, make sense. The reason I say 'in theory' is that while funds intend to deliver consistently attractive, positive returns regardless of market conditions, in practice this is rare. Absolute return managers still have to exercise judgement on which direction markets (whether it be stock markets, commodities, currency or interest rates) are headed and, being human, they won't always be right (some will be wrong more often than others).

Looking at your suggested funds in turn:

Troy Trojan - invests in a mix of shares, fixed interest, cash and gold, but it doesn't 'short' investments, i.e. place bets on falling prices. Performance has been good the last couple of years (when most assets have risen in price) and flat the two years prior (when markets were in turmoil), so respectable overall. However, it's currently closed to new investors.

Ruffer Total Return - a similar approach to the Troy fund (mix of assets and no 'shorting') and it has delivered consistently positive returns since launch 10 years ago, albeit sometimes falling well short of the 10% annual target. At £2 billion in size the fund could prove unwieldy, but as the managers focus on larger companies and securities it doesn't seem to have been a problem to date.

Newton Real Return - another mixed asset fund, although it can use options for downside protection. It has delivered positive returns, but did struggle during market falls in late 2008.

Insight Absolute - invests in a range of Insight's other absolute return funds. This gives access to a number of different absolute return strategies (e.g. mixed asset, shorting and currency bets). Returns were minimal (albeit positive) during the credit crunch but have been ok over the last couple of years (not difficult!).

I don't think any of these funds would be a bad choice, but bear in mind they could still lose you money. I'd be nervous about investing for less than five years and longer would be good (maybe I'm a pessimist, but I don't like to trust that absolute return managers will deliver year in year out). Perhaps also consider another fund that makes more extensive use of 'shorting', like Gartmore UK Absolute Return or Blackrock UK Absolute Alpha. Returns from the latter have been negligible the last 3 years, but this style of fund could come into its own if markets dive.

I would be tempted to keep some cash aside for the next few years in case the absolute return funds don't perform. Interest rates aren't great, but fixed rates over 1-5 years of between 3.5%-5% look reasonable given (in my opinion) the Bank of England Base Rate is likely to remain rooted at 0.5% for some time yet. If your wife is a non-taxpayer then holding savings in her name would avoid tax on any interest that doesn't fall above her personal income tax allowance.

Good luck whatever you decide and happy retriement.

P.S. If readers have view/suggestions re: absolute return funds please post them below.

Read this Q and A at http://www.candidmoney.com/questions/question491.aspx

Tax on deferred state pension?

Question
My female friend is 65 in December and will be retiring from work 31/12/2011. She is a 40% tax payer; gross earnings around £57000 under PAYE. She has deferred her State pension for the past five years so is it advantageous for her to not take the lump sum available (approximately £32000 basic tax deducted) until the beginning of tax year 2012/13 when her tax rate will have fallen to basic rate level?

Also as her basic tax code for 2011/12 will increase to 9940 in December 2011 does this impact on the whole of the current tax year? If so is it desirable for her to contact HMRC now to tell them her intentions to retire as this will take her out of 40% bracket for this tax year, assuming she does not take any pension until the beginning of next tax year.Answer
If she takes the lump sum option from a delayed state pension the entire amount is taxable at the highest rate paid on her income that tax year. Given her gross PAYE income this tax year will be around £38,000 she should be comfortably below the higher rate threshold (£42,475), provided she has no other income this tax year.

Because the lump sum isn't added to her income when calculating the tax owed (it's just taxed at the highest tax rate paid on other income that year), she should be able to take it in December net of basic rate tax.

If she could arrange to be a non-taxpayer next tax year (e.g. by deferring other pensions) then she could potentially receive the deferred state pension lump sum tax-free, so there would be a benefit waiting until 6 April 2012 if this is feasible.

The increased age-related personal allowance applies for the whole tax year in which she turns 65, so a birthday in December means she'll enjoy the £9,940 allowance from 6 April 2011 to 5 April 2012. However, the allowance reduces by £1 for every £2 of income above £24,000, subject to not falling below the standard £7,475 allowance. So the extra age-related allowance will be fully wiped out by an income of £28,930 or more.

It would be sensible to contact HMRC to try and get her tax code changed so that she doesn't end up paying too much tax this year. However, I wouldn't count on them getting it right and suggest she double checks everything and reclaim any overpaid tax using form P50.

Read this Q and A at http://www.candidmoney.com/questions/question490.aspx