The Mists of Time
Well it’s not every day that I get an e-mail in about things I wrote over seven years ago, but strange things do happen. It happened this week in fact when stalwart BeeLiner Richard Fair wrote in raving about two press articles from the 2001 archive on the BeeHive (I know; I thought that too, but as my mum used to say, it takes all kinds). Perhaps it’s the revamp of the BeeHive that’s got everybody re-reading all the old BeeLines and press articles with a new enthusiasm? Or perhaps it’s just that some of us just find ourselves at a loose end every now and then; who knows?
Anyway, on re-reading these old articles Richard wrote in to say that he felt they were “just as relevant today as they were then” and went on to suggest you might all like the chance to read them again too (in fact what he actually said was “how about dusting them off and re-publishing?”, but you get the idea.)
Richard’s enthusiasm led me to read the press articles again myself to see what they were about. They’re of their time, of course, but I can see their current relevance. So, and in a BeeHive first, I’ve reprinted both of the articles here so that you can read them once more if you’d like to too. The first one is about fees and commissions and was published in Money Marketing on November 15th 2001. That was years before the FSA’s Retail Distribution Review and makes the older and wiser me feel I may have had a touch of the Nostradamus about me when I wrote it. Here it is:
There has been much said lately about fees and commissions and the benefits or otherwise of each system of intermediary remuneration. Some newspaper articles will lead you to think that fees can cut the cost of advice, whereas basic maths will tell you that in many cases the opposite is true. Others will tell you that commissions are fine and that ‘good’ IFAs rebate commissions to clients anyway so what is all the fuss about. Well, I think the fuss is about perception in the main, pure and simple, and in the black-and-white world of the popular press it is fees that are good and commissions that are bad.
This leads me to believe that, in principle, fee payments to independent intermediaries are preferable to commission payments. But, importantly, I believe the level of fees payable for financial advice should be agreed between financial advisers and their clients; not only when advisers choose to do this, but every time advice is given. Although product manufacturers need to facilitate fee arrangements for such financial advice, I believe they should not be able to impose restrictive remuneration systems on advisers. However, and again importantly, I am also of the view that people should be given the option of generating fees to pay for advice from within financial products as a way of reducing the cost of advice.
There are good reasons why people would prefer to, or would be advised to, pay for financial advice from within a financial product rather than by paying a fee from other financial resources. From my company’s experience of dealing with the financial welfare of customers across the whole spectrum of society we are extremely concerned that a system that allowed only for fee payments for financial advice would be socially exclusive. In our view, such a system would mean in practice that only the better-off would have access to financial advice.
Because of the way the UK tax system operates, people paying fees for financial advice may pay more than those who choose to pay their advisers through the commission system. In particular, where pension products are used to generate commission payments the tax savings available to individuals are substantial; a standard-rate taxpayer would pay half as much again for advice if payment were made by fee rather than commission and a higher-rate taxpayer would pay twice as much.
In a practical example a higher-rate taxpayer who is advised to invest in an individual pension may owe a fee of, say, £200. In real life how can he go about paying the £200 fee? One way would be to go to his building society and draw the £200 from his savings and pay it to his adviser, but he would have to draw an extra £35 from his savings account if his adviser is VAT registered and pay that on to the Inland Revenue. So, he could pay the £200 for the advice he has received by drawing £235 from his savings.
But, in real life there is another way he can pay the £200 fee whereby he will not be liable for the £35 VAT and the Inland Revenue will also pay £80 of the fee for him. This is achieved through a much misunderstood process called ‘commission’. He could take £200 from his pension product through the commission system. Commissions can be thought of as ‘fee-generators’ in this respect. Where this is done, no VAT is due and, in this case, £35 would be saved immediately.
However, although a saving has been made, the pension product has been damaged to the tune of £200 in the process. So, what if this chap wants to repair the £200 damage to his pension, how can he do that?
Well, he could go to his building society and draw out £120 and pay it into his damaged pension as a single premium. If he does this the Inland Revenue would become obliged to add a further £80 to his personal pension as tax relief, thus fully reinstating the personal pension to its previously undamaged state.
The end result in both cases is the same; the full fee has been paid to the adviser and the pension has been left unscathed. The person being advised, therefore, has the option of raiding his savings of either £235 or £120 to achieve exactly the same result, the payment of £200 for the advice given.
It is for these reasons that, while supporting the principle of fees against commission payments, I would recommend that people should maintain the right to use their financial products to generate the fees needed to remunerate financial advisers. In plain English I am saying that I am in favour of fees, but do not want people to lose the substantial tax benefits contained in the existing commissions system.
First published in Money Marketing, Nov 15 2001
The second article is a shorter piece that I wrote for Pensions Management magazine. It was published on the 1st of October 2001, five years before I engaged in my so-called ‘Battle of the Blogs’ with Pensions Minister James Purnell. In fact, James Purnell, who is now Secretary of State for Work and Pensions first became an MP in 2001, so I guess you’d say that the argument we were later to have about means-testing was already there waiting its time. On my part, I guess, it shows both persistency and consistency and the argument, of course, still hasn’t been resolved.
Here’s that article:
I was speaking to a group of my actuarial chums the other day about the way means-tested state benefits play havoc with pensions distribution in our modern world of pensions. We were having a reasonable discussion on the subject of the Minimum Income Guarantee (MIG) and the soon-to-be-with-us Pension Credit system and I was saying that the value of the MIG was a serious obstacle to many of the people in the workforce who are so far unpensioned. At the level of £100 a week, or around £5,000 a year, the capital value of buying a pension equivalent to the MIG could be something like £80,000.
Well, that started it off; half the actuaries there thought £80,000 was an understated figure and the other half thought it was overstated. Now, I don’t know who’s right and who’s wrong, and I don’t particularly care - I only read it in a newspaper somewhere anyway. The point is it’s a lot of money to put aside for a benefit that is provided free to those who don’t save and that’s a problem that goes to the heart of any attempt to provide a means-tested safety net from the state. The level of saving we’re talking about is something like the value of the average house in the UK and is therefore not inconsiderable - that’s the point I was trying to make.
I wanted us to go on to discuss whether pensions reform could ever be effective if it did not include a complete reform of the way pension savings interact with means-tested benefits and whether it was cost-effective to distribute pensions which are not inherently suitable for all. I then wanted to go on and explore some ideas I have for disinvestment as an alternative to enforced annuity purchase for those whose lifetime pension savings are not sufficient to purchase a pension equivalent to the MIG. But that’s not the way it panned out. We spent the whole of the time arguing over what the correct figure was, whether there was in fact a correct figure, and, where were all the index-linked gilts going to come from anyway? I found it quite an exhausting afternoon, but I would say that if anyone ever tells you a group of actuaries can never agree on anything, don’t believe a word of it. Believe the whole sentence!
First published in Pensions Management, 01/10/01
I think Richard’s right, these issues are still highly relevant in 2009 even though they were written way back in 2001. By the way, if you want to read these two pieces from the BeeHive archive direct you can get to see them by clicking on the following links:
Me, I’m going to start re-reading all the things I wrote in 2002 to see what’s going to be relevant next year in 2010.
Spooky or what?
22 January 2009
Any research and analysis has been provided by us for our own purposes and the results of it are being made available only incidentally.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.