How RDR affects you

Rule changes resulting from the FSA's Retail Distribution Review (RDR) have now kicked in, with more to follow by the end of this year. How do they affect you?.

I've covered various aspects of this before, but now seems an opportune time to recap how the changes might affect you.

Let's look at each key area in turn:

Financial Advice

There are now just two categories of adviser: restricted and independent. Independent advisers must be willing and able to select products from the whole of the market. Restricted advisers are those unwilling/unable to do so (they used to be called 'tied' or 'multi-tied').

Both must work on a fee basis, hence can no longer receive sales commissions from product providers, e.g. insurers and fund managers.

However, the commissions ban only applies to new sales from 31 December 2012, so ongoing (trail) commissions being paid on products sold before then may continue. This means some advisers might be less inclined to recommend you switch/transfer older policies, as it could turn off the commission tap that feeds them and incur the hassle of trying to charge you fee. Read more about trail commission in our guide here.

Fees may be paid directly to an adviser or, with your permission, taken from the product you're buying (called 'adviser charging'). So, for example, an adviser might charge a 3% initial fee and ongoing 0.5% annual fee, to be taken from the fund you're buying. This looks very similar to the commission system, but the key difference is the adviser sets the amount he/she receives, not product providers - removing the temptation to use one provider over another because it earns them more (as happened under the commission system).

Of course, the new system is still open to abuse. An adviser might smooth talk their clients into paying excessive fees to be taken from products. And you'd be surprised how relaxed clients tend to be about fee levels when they're not having to write out a cheque directly to an adviser - it's somehow perceived as 'free' - which is why unscrupulous advisers/providers found the commissions regime so easy to abuse. But as adviser fees are supposed to be clearly disclosed to and agreed to by the client - this should hopefully be a big step forward in cleaning up a tainted industry.

As for the fees themselves, most advisers are charging either hourly fees or percentage fees on the amount invested. There's no right or wrong here, the bottom line is how much you actually end up paying. With hourly fees it's best to get the adviser to agree a fixed cost for the work, to avoid signing a blank cheque. Percentage fees can work well for investments, as it motivates the adviser to increase the value of your portfolio, but for larger sums you'd want some sort of cap to avoid the fees becoming excessive.

Regardless of fee type, even the most honest of advisers will want to charge you more the more you invest. This is in part because it might involve more work and also because it will increase the adviser's liability to compensation if things go wrong, i.e. it's more risky for them.

The key is to understand exactly what you're paying, how it'll be paid and what you'll receive in return.

The minimum qualification bar has also been raised for all advisers, to something called 'QCF 4'. There are various ways advisers can achieve this. I won't bore you with the permutations here, but in summary it's a good thing. Although not that difficult to attain it does require a fair amount of commitment, deterring fly by night salesmen. Some advisers take further exams to achieve 'Chartered' status. This is a serious qualification and while no guarantee of good or honest advice, suggests the adviser takes their career very seriously.

Execution-only transactions, e.g. discount brokers

If you don't take advice then it's business as usual, for now at least, as commissions can continue to be paid on both old and new business (allowing discount brokers to continue rebating them). However, it looks likely the FSA will ban commissions on non-advised sales too in due course, perhaps even by the end of this year. If/when that happens it's likely discount brokers will have to offer commission-free products (which should be cheaper) and levy an administration fee instead.

Fund Platforms

Since 31 December 2012 all fund platforms have finally been compelled to allow you to transfer your funds 'as-is' to other platforms (even Cofunds & FundsNetwork, who resolutely refused such ISA transfers before). Of course, this will only be possible when identical funds (down to fund class) are available on the new platform. While most platforms charge for this (typically between £10-30 per fund), Cofunds and FundsNetwork are not, for now at least.

Fund platforms who accept business via financial advisers have had to make some changes, primarily avoiding funds that pay commission and allowing advisers to take their fees via the platform (if that's want their clients want). The former has led to an increase in 'clean' fund classes being offered, more on that in a moment.

However, the biggest change has yet to come. By the end of this year platforms will no longer be able to accept payments from fund managers, meaning they'll instead have to charge customers directly. If you're a customer of Alliance Trust Savings or Interactive Investor this is what happens already, but it might come as a shock to those Hargreaves Lansdown customers not currently paying any explicit fees to use the Vantage platform. While the change might not affect overall cost, the transparency it brings will alert many to the costs involved of using fund platforms.

Funds

Funds sold by financial advisers can no longer have sales commissions built into their charges. In general this now means no initial charge and 0.5% trail commission being knocked off the annual charge. To accommodate this, fund managers have done one of two things, either let advisers use the 'institutional' class (i.e. version)of their fund (previously only available to big-wig investors like pension funds) or issue a new 'clean' fund class - neither includes commissions.

Fund classes all invest in the same fund, the only difference being charges, the letter after the fund name (e.g. A, B, C, I, X etc) and sometimes the minimum allowed investment.

Institutional fund classes seldom include fees paid to fund platforms, typically 0.25% a year. So a fund that charges 1.5% a year with 0.5% commission and 0.25% platform fee would usually be 0.75% for the institutional version (i.e. 1.5% - 0.5% - 0.25%).

Unfortunately, the new so-called clean fund classes aren't always that 'clean', because some still include platforms fees, so the annual charge is more likely to be 1% rather than 0.75%. This isn't a problem if you use a platform that takes fees from fund managers rather than charging you directly, but you'll lose out in favour of the fund manager when platforms that don't take fees from managers offer such fund classes.

The clearest example to date is Invesco Perpetual, who currently only offer unit classes which include platform fees, even if a platform doesn't take them. So Alliance Trust Savings customers ( who pay to use the platform) end up paying an annual charge of 1% on the Invesco Perpetual High Income fund while Invesco Perpetual keeps the c0.25% that would otherwise be paid to some competitors. It smacks of Invesco Perpetual playing hardball (the High Income fund is a 'must have' for all platforms). Let's hope platforms push them harder over the coming months to act more fairly for investors.

A new platform comparison tool

As you can see from the above, platform and fund charges are becoming more complex (at least in the short term), so comparing like with like can be very difficult. Because of this I've been busy building a dynamic fund platform comparison tool, allowing you to compare total costs between leading platforms for your chosen funds. To avoid further confusing this site, it'll launch on a standalone site, www.comaprefundsplatforms.com, on 21 January. I'll put up more details shortly.

Read this article at http://www.candidmoney.com/articles/264/how-rdr-affects-you

How much does Nucleus fund platform cost?

Question
Our new IFA of 24 months has put all our ISAs into the 'Nucleus' platform(?). Total value of about £185,000. Roughly what sort of total charges should we be looking at per annum from both Nucleus and the IFAAnswer
I hope your adviser clearly explained the charges you'll incur before you proceeded with the advice. They're compelled to disclose them and any good adviser should spend time running through them to ensure you're comfortable and understand what's going on.

Anyway, Nucleus itself is one of the more transparent fund platforms as it doesn't take platform fees from fund managers, instead charging customers percentage fees - 0.35% a year on balances below £1 million.

It uses low cost institutional versions of funds where possible (which strip out commissions and platform fees from charges), to ensure rock bottom fund charges.

So, for a typical fund you'll be paying a 0.75% annual fund charge, the 0.35% Nucleus annual charge plus whatever your adviser is charging. Funds on Nucleus seldom have initial charges and Nucelus doesn't levy any itself, so the only initial costs would be those charged by your adviser.

Ignoring the adviser for a moment, the typical 1.1% combined fund/Nucleus charge is a bit higher than you'd typically pay via platforms like Alliance Trust Savings on £185,000, but not excessive.

If your adviser charges an ongoing percentage fee then up to 0.5% is probably fair depending on how good they are at selecting funds and the level of service they provide. Although a cap to prevent fees becoming excessive on larger sums would be preferable. Any more than that and I'd be reticent, unless the adviser truly is an investment guru who makes you a mint.

Read this Q and A at http://www.candidmoney.com/askjustin/790/how-much-does-nucleus-fund-platform-cost

Was transferring to a SIPP a bad idea?

Question
I have put my SIPP with a well known company, but after a year, see that the returns they made for it are just about wiped out after charges. The fund value is only £100k, and I am wondering whether a SIPP is the right option. I am age 62, have deferred the date until I am 70. I think I could get a better return myself, but of course can't draw it all out. Any advice please?Answer
The key things to consider are how much you're paying for the SIPP wrapper, the cost of the underlying investments held and the quality/cost of any advice you've taken. And, of course, whether you're actually benefitting from the increased investment selection that SIPPs offer.

Without knowing which SIPP and underlying investments you're using, I can't comment on their cost. But take a look at our guide to low cost SIPPs to get a feel for what's reasonable.

If you've used an adviser they've probably taken the bulk of their remuneration (either commission or fees) at the outset, which would have a greater impact on returns over the first year than subsequent. It would be worth checking whether you're paying ongoing amounts to an adviser, as these will obviously further eat into returns (although if the advice is good they may be worthwhile).

If you're not using an adviser then I assume you're holding some funds you've chosen yourself. This is likely a cheaper option, whether it's better depends on your investment selection versus an advisers. In any case, a year is too short a timescale to judge performance.

As you're only 8 years away from retirement it's important to consider how you plan to take an income from the pension when you get there. You'll have the option to swap the pension fund for an income for life via an annuity, or leave it and draw an income (commonly called 'income drawdown').

If you plan to buy an annuity then I'd avoid taking excessive risk. In fact, you arguably want to take very little risk at all at this stage (as a crash over the next 8 years could severely hit your retirement income), but it's a personal choice. It's debateable whether income drawdown is sensible on a £100,000 pension fund, it largely depends on your overall financial position. However, if this is your aim you could possibly afford to be a little less cautious as the money could remain invested for a lot longer - although losses would still hurt.

Provided the SIPP charges are reasonable, you probably haven't made a mistake (unless you paid hefty penalties to transfer your previous pension into the SIPP). The extra investment selection could prove useful and provided you invest sensibly you'll hopefully end up sitting pretty. However, if you're using an adviser I'd watch closely to ensure they know what they're doing investment-wise (a surprising number don't!) and that you're getting value for money.

Feel free to post further details below and I'll follow up.

Read this Q and A at http://www.candidmoney.com/askjustin/789/was-transferring-to-a-sipp-a-bad-idea

Most tax efficient investments in ISAs?

Question
Since Corporation Tax is deducted from dividends paid by UK companies is it a good move to have Equity Income Funds invested in ISA's or would it make more sense to have only growth funds within the ISA wrapper and leave Equity Income investments outside of the ISA?Answer
From a tax point of view you're actually better off holding interest paying investments, such as corporate bonds within ISAs. A brief overview as follows:

As you mention, dividends are paid out of company profits on which corporation tax is paid. They're effectively deemed to be paid net of basic rate tax, although this cannot be reclaimed by non-taxpayers, nor within an ISA/pension. Basic rate taxpayers have no further tax to pay while higher rate taxpayers owe an extra 25% of the dividend received (based on current tax rates). So basic rate taxpayers will not save any income tax by receiving dividends within an ISA, but higher rate taxpayers will save 25%.

As for gains, they're tax-free within an ISA. Outside of an ISA you can offset realised gains (i.e. actual gains from selling, not paper gains) against your annual capital gains tax allowance, currently £10,600. So this may not be an issue, depending on the level of gains you anticipate outside of ISAs.

Interest received within ISAs is tax-free. This means basic rate taxpayers save 20% income tax and higher rate taxpayers 40% on income from the likes of gilts and corporate bonds held within ISAs.

Of course, no point holding interest paying investments within ISAs to save tax if you wouldn't otherwise buy them. But if you do have some then these should generally take precedence in your ISA unless you regularly exceed your annual capital gains tax allowance.

Whether equity income or growth investments should be preferred within ISAs depends on your tax position. For example, basic rate taxpayers who don't regularly use their capital gains tax allowance won't save tax from holding either in an ISA, whereas a higher rate taxpayer would at least avoid paying extra income tax on dividends.

But I think the bottom line is invest in what you believe in,. then look at tax as a secondary consideration. And provided you're not paying for an ISA wrapper then use one anyway, even if you won't save tax at first - it makes admin simpler and might save tax in future if your situation changes.

Read this Q and A at http://www.candidmoney.com/askjustin/788/most-tax-efficient-investments-in-isas

Do backhanders compromise fund research?

Question
I use several discount brokers' websites and rating websites to give me ratings for funds. (Morningstar, Citywire, Lipper, Hargreaves, Bestinvest, Close, etc.). I understand that backhanders/overriders/secret commissions are given to some brokers to promote certain funds or fund providers. Are you able to confirm this, and which do receive these? Is the RDR going to prohibit this practice, or compel the transparency of this practice?

How can I know whether highly rated/Best buy funds are the result of these incentive-based payments?Answer
An interesting question, thank you. I'll do my best to cover your concerns, but as things stand there's still insufficient transparency to give a definitive answer. So I don't get sued, let's define backhanders/overriders and 'secret' commissions as an amount of money received that isn't explicitly disclosed to the public.

Let's start with Morningstar, Lipper and Trustnet. These companies make the majority of their revenue from selling investment data, usually costing thousands of pounds a year. Their target market is financial services companies and websites, although Morningstar and Trustnet offer free consumer websites with limited data available. Given their ratings appear to be based solely on quantitative analysis, i.e. performance, there's little scope for bias - even if they subsequently charge fund managers to use the ratings for marketing purposes.

Citywire is a well-regarded financial publisher, that generates a fair amount of its revenue from charging fund managers for advertising, displaying ratings and events etc. So, on the surface, some cause for concern that this could lead to bias. It publishes two ratings: Citywire Selection and Citywire Fund Manager Ratings. The latter is entirely stats driven, so no scope for bias. Citywire Selection involves human judgement in the ratings process, so in theory this could be influenced by commercial pressures. Citywire says no on its website and I believe them - but no way of knowing 100% for sure

Hargreaves Lansdown and Bestinvest both publish research, primarily to support their main business of selling funds. They also both operate their own fund platforms ('Vantage' and 'Select' respectively).

As both are execution-only services they're allowed to continue receiving sales commission, which must obviously be disclosed. I've never bothered to check whether there's a correlation between levels of commission paid and the ratings given by each firm, but I very much doubt it - commissions are largely standardised in any case.

More of a grey area is the platform fees received by each company from fund managers, as neither company currently discloses these. They come out of annual fund charges, so not an extra fee, but they could obviously give potential for research/marketing bias if some fund managers pay higher fees than others. As the amounts aren't disclosed, it's impossible to get a clearer idea of whether this might be an issue.

Both the above should cease to be potential issues in due course. The FSA plans for fund platform fees to be paid customers and not fund managers by the end of this year. And a ban on execution-only sales commissions also looks likely within the next couple of years.

More generally, I think fund managers often contribute towards costs when brokers/advisers send marketing mailings featuring that manager's fund(s). Payments should only cover the actual cost of printing/postage etc, hence not a way to profit, but I suppose a manager who's reluctant to pay reduces the chances of their fund's inclusion, no matter how good it is. Again, there's no transparency here, it would be nice if the FSA compelled companies to disclose this information where applicable.

Adviser/broker research analysts often attend lunches and the occasional working trip abroad, typically paid for by fund managers. Again, it would be nice to see recipient companies either disclosing such hospitality or outright refusing it, but as the practice is so widespread I think the risk of this influencing research is minimal - it certainly didn't seem to influence Bestinvest's research during my time there (2003-2007) - the analysts were very focussed on selecting funds that would be best for clients.

In summary my gut feeling is that undisclosed payments probably have, on occasion, affected the research published at some companies (which ones? I don't know). But, even if true, I suspect this is probably at the margin - for example giving preference to one of two good funds, rather than slapping a decent rating on a poor fund. Nevertheless, it would be nice if the world was more transparent (including financial services), but I guess that's life...

Read this Q and A at http://www.candidmoney.com/askjustin/787/do-backhanders-compromise-fund-research

Difference between fund unit classes?

Question
Merry Christmas and a Happy New Year. Thank you for your excellent answers.

Q1 When I'm buying funds on a supermarket site, I'm ok when confronted by the options R/retail and I/inst, though I occasionally wonder what would happen if as private investor I chose I/Inst. But when I'm confronted with the options A, B, and X - or more particularly, just B and X - I'm lost. Please help.

Q2 Income funds with holdings in many different dividend paying companies are I assume receiving dividends very frequently. When do these dividends get fed back into the fund if the fund is (a) an Acc, or (b) an Inc and pays out (as cash or by reinvestment) only once or twice a year?Answer
Thanks, Happy New Year to you too.

Re: your first question, yes, fund unit classes are confusing and it's likely to get worse.

The different letters after a fund, e.g. A, B, I, R, X etc refer to different classes of unit in the same fund. They all invest in the same fund, but usually have different charges and, sometimes, minimum investment limits. Unfortunately there's no standard, although 'I' usually means institutional units (low cost, high minimum investment pitched at professional investors), so without referring to the fund provider in question deciphering what they mean is nigh on impossible.

In the past this wasn't much of a problem, as there'd only be one unit class available for private investors. But times are changing. Following the Retail Distribution Review most fund providers also offer unit classes without commission and some have also started to offer classes without fund platform fees built in too (which is effectively the same as institutional, but without the high minimum investment). Before long, we could see funds having half a dozen or more unit classes, with little rhyme or reason as to what they mean.

If you see an intuitional fund available on a platform then you should be able to buy it if you the platform lets you - the minimum investment level is the platform's problem, not yours. Platforms sometimes offer several unit classes for a particular fund which seems a bit dumb, they should just offer the cheapest. However, it can sometimes help if you want to re-register your funds from one platform to another, as this is only possible if the same unit classes are available on both.

Anyway, when buying funds on a platform and more than one unit class is available, check the charges for each, net of any commission rebates (which still apply to pre 31 December 2012 purchases and new execution-only purchases) and opt for the cheapest.

As for dividends, when a fund receives them it puts them in the bank then pays out the balance to fund holders on set dates (e.g. quarterly, half-yearly). The fund price will rise meanwhile to reflect the dividends it's holding, as the bank balance is included in the fund's assets. When a fund hits its ex-dividend date, that is the date from which new purchases don't receive the next dividend payout (typically a couple of months before the dividend is paid out), you'd expect the price of income ('Inc') units to fall by the amount of the dividend to be paid out as new owners won't receive it. Accumulation units receive dividends via an automatic increase in unit price (dividends are effectively used to buy more shares per unit owned), so the ex-dividend should have little impact on price.

Read this Q and A at http://www.candidmoney.com/askjustin/786/difference-between-fund-unit-classes

How to get money out of company tax efficiently?

Question
I have a limited company from which I hardly draw any salary or dividends. Would it be more tax efficient to pay for my and my wife's iSAs from the company rather than from our earned salary from another job (public servants)?.The limited company is for my private earnings. We are both higher rate tax payers.Answer
Nice idea, but unfortunately it's not allowed - ISAs can only accept contributions from individuals, not companies.

To get money out of a company it must be taken as income or a dividend, both are taxable. Dividends have the advantage in that they're not subject to National Insurance (NI), but HMRC tends to clamp down if it thinks you're paying an artificially low salary with high dividends to avoid NI. Dividends are also deemed to be paid net of basic rate tax, reflecting the fact they're paid out of taxed company profits.

You could pay money from your company directly into a pension for yourself (or your wife, provided she's a director/employee), this would be treated as a business expense hence avoid corporation tax on the contribution. However, bear in mind pensions are not very flexible, the money will be tied up until at least age 55 and must eventually be used to provide an income - you can't simply get the money back whenever you want it (unlike ISAs).

If you consider pension contributions, check you don't exceed your annual overall contribution limit of £50,000, this includes your civil service pension and any employer contributions. Also bear in mind the lifetime allowance, currently £1.5 million. If your pension pot is valued above this at retirement the excess will be taxed, currently at 55%.

Both the annual contribution limit and lifetime allowance are due to fall from April 2014, to £40,000 and £1.25 million respectively.

Read this Q and A at http://www.candidmoney.com/askjustin/785/how-to-get-money-out-of-company-tax-efficiently