Boost your pension by 25%!

Find out the easy way to cut the cost of your pension and give the value a massive uplift.

Pensions have a poor reputation for many reasons - the mis-selling of personal pensions, the tax raids by the government, not to mention the numerous scandals and long-term underperformance of pension funds themselves.

But there’s another reason why many people don’t like pensions. They’re seen as unnecessarily expensive with rip-off charges decimating returns.

Luckily, it doesn’t have to be like that. If you’ve got pension schemes with high charges, you now have every right to transfer them to a more reasonably priced plan. This is particularly true if you have an older style personal pension scheme which is likely to be far more costly than modern low cost plans.

How expensive is expensive?

You may be surprised to hear that even a seemingly marginal difference between charges can have a monumental effect on how much your pension could be worth when you come to retire.

In fact, an extra 0.25% on the annual charge can literally wipe thousands off the final value of your pension.

You can easily understand why it’s so important to get great value for money when it comes to saving for your retirement. The pensions industry itself has attempted to improve matters by introducing price caps. The stakeholder pension initiative, for example, which was launched in 2001, intended to bring low-cost pensions to the masses. It restricted pension providers by permitting fees of no more than 1.5% of the pension fund value per year, dropping to a maximum of 1% after ten years.

Price caps are a great idea in theory, but in practice stakeholder pensions failed to take off, with many schemes now left as nothing more than empty shells with no members. Worse still, many schemes which preceded stakeholder are even more costly.

The table below demonstrates the devastating effect excessively high charges can have. I’ve compared the final value of a pension fund with an annual fee of 0.5%, rising up to 2%. The figures are based on the following assumptions:

• You invest £200 a month from age 35 and
• You retire at 68 and
• Your pension fund grows at 7% a year.

How charges can affect your pension fund value

If you managed to find a low cost pension plan which charged just 0.5% a year, your fund value could potentially be worth over £153,000 by the time you reach your 68th birthday and retire. But if the charges increased to 0.75%, your pension fund could be worth over £7,000 less, losing almost 5% of its value even though the costs have only stepped up by 0.25%.

Obviously, the higher the charges the worse the final result becomes. If the annual fees were four times higher at 2%, you could lose more than £38,000 - that’s equivalent to a quarter or 25% of what your total pension fund would have been worth if you had chosen a cheaper scheme. 

How can you avoid high pension charges?

As I mentioned earlier, if you find you’re stuck in a high charging scheme it’s time to take action by transferring it to a new low cost plan. But before you make the transfer, you should make sure you’re not inadvertently sacrificing valuable benefits which are part of your original scheme.

Transferring a pension is never a decision to be taken lightly. Take a look at Why you should transfer your pension for a rundown of all the factors you need to consider.  

The next question you should consider is: where should you switch your old scheme to?

As you may already know, at lovemoney.com we’re fans of index-tracking funds which can be held within pension wrappers. Index trackers are designed to replicate the returns generated by a particular index. So a FTSE 100 index tracker, for instance, will perform in more-or-less the same way as the FTSE 100 index itself.

The great news is, some index trackers are very good value for money. Several funds including the HSBC FTSE All Share Index Tracker Fund and the Fidelity MoneyBuilder UK Index fund charge well below 0.50%, while certain tracker funds from US asset manager Vanguard charge even less (although they aren’t widely available to UK investors).

Bear in mind all trackers work in roughly the same way, so there’s absolutely no reason to pay higher fees.

Try a low cost SIPP

At this point, you should also think about moving your old pension scheme into a newer style low cost SIPP. SIPPs - or self invested personal pensions - give you the opportunity to take control of your own retirement planning by allowing you to choose which assets you want to invest in.

This doesn’t necessarily haveto be hard work. You can, for instance, use a low cost SIPP as a wrapper around cheap index tracker funds. But bear in mind that most SIPPs charge an initial fee for setting the plan up, as well as annual administration costs and annual management charges on the funds or assets you choose. Dealing costs may also apply if you use your SIPP to buy and sell shares.

Look out for SIPPs which keep these costs down to a minimum or better still 0%. For example, the Select SIPP from Alliance Trust Savings charges nothing for setting your pension up, and a relatively small annual admin charge of £75 (+ VAT). Similarly, the Transact SIPP from Integrated Financial Arrangements also charges nothing to set your plan up with a flat annual admin charge of £80.

Meanwhile, the eSIPP from James Hay and the Sippdeal SIPP are even better value and don’t charge anything at the outset or for running your pension. But don’t forget fund charges and transactions charges will still apply depending on how you invest your SIPP.

So you can see it’s actually pretty easy to slash the cost of your pension. But I’ll finish with a few words of caution: Never buy a pension or SIPP solely on the basis of low charges. It needs to be the right plan for you in all respects, as well as great value for money. If you’re unsure which provider to choose, seek help from an independent financial adviser.

Compare index trackers at lovemoney.com

More: How to build a fat-cat pension | Pay attention if you earn less than £33,500