How to avoid a pensions rip-off

High charges can inflict serious damage on your pension. Here's how to avoid a pensions rip-off.

Saving into a pension fund should be a great way to secure a comfortable retirement. In theory, anyway. Sadly, in practice, too many people have been very disappointed with the return they’ve received from their pension when they retire.

Before I go any further, I should say that this article isn’t about final salary pensions. If you’re lucky enough to have one of these pensions, you probably don’t need to read any further. In this piece, I’m looking at defined contribution pensions where you and/or your employer are making regular contributions into a pension fund. That fund will then buy you an annuity when you retire.

Now, there are several reasons why many defined contribution pensions disappoint, but I believe that high charges are the most significant. If £30 out of every hundred you save goes to a pension company, it’s much harder to build a decent sized pension pot.

A new survey by Money Management magazine reveals the highest charging funds over the last 25 years. Top of the list is a fund from HSBC Life. If this had been my pension fund, I’d be very fed up because 41% of my fund would have been lost to charges over that period. That’s way too high in my view. A true pensions rip-off!

And the HSBC Life fund isn’t the only one that charges too much. Money Management’s survey highlights several other funds where the charges are just too high.

So how can you avoid being hit by a pensions rip-off?

Steer clear of with profits

Many pension funds – especially older ones – are ‘with profits’ funds.  The with profits concept sounds sensible when you first hear it, but, in reality, they're bad news.

The idea is that the fund will hold back some of its profits in the years when the stock market does well, so that it can pay out more when markets are suffering. As a result, the investor’s return will supposedly be ‘smoothed’ between good times and bad. Trouble is, many funds paid out too much money to investors in the good years, and as a result they’ve not been able to deliver the promised ‘smoothed’ return in the bad years.

More importantly, charges for with profits funds are high. These funds are best avoided if you can.

Even 1.5% is too high

It’s not just with profits funds that charge too much. Personal pensions are a widely used kind of pension and are usually seen as a low cost option. However some funds charge as much as 1.5% a year which may not sound that much but can build up to a sizeable sum over a long period of time.

Let’s look at a 25-year old who saves £1000 a year into her pension. Assuming annual growth of 7%, she can expect a pension pot of £248,170 at 65. However, the 1.5% annual charge brings that down to £174,560, according to Hermes. That’s too big a fall, so it makes sense to try and push the commission down as much as possible.

One option is to go for the Aviva Stakeholder pension which charges 0.9% a year if you apply online.

However, my favourite option is a low-cost Sipp. The best of these pensions offer a wide choice of investments and also have low charges.

For example, I really like the Hargreaves Lansdown Vantage Sipp which has no set-up fees and doesn’t charge you an annual management fee for any money invested in funds or cash. Admittedly, you will, have to pay an annual charge to the company that manages the underlying funds in your pension, but if you go for an index tracker fund, the annual charge can be as low 0.25%.

Choice

The only problem with low-cost Sipps is that they’re not really a viable option for many people. That’s because many employers have chosen to offer a different kind of pension scheme. If your employer is willing to pay contributions into a pension fund for you, then I’d focus on that pension scheme regardless of the charges.

In other words, if your employer is willing to contribute, say, 5% of your salary into a pension scheme as long as you also pay in 5%, then sign up for that scheme. Even if it’s a with profits product! Then if you want to do any pensions saving on top of that, you could always set up your own low-cost Sipp. Or you could transfer an old pension from a previous employer into that Sipp.

The most important thing is that you save into a pension. The second most important thing is to pay charges that are as low as possible....

More: Ten top pension tips