In the time I have been advising clients on their existing pension structures, I have noticed an equally surprising and worrying trend – the use of investment bonds within international pensions, specifically QROPS.
A QROPS is a Qualifying Recognised Overseas Pension Scheme, and this type of pension is used by UK residents who wish to retire abroad and transfer their pensions with them. This type of product is popular amongst UK-resident retirees who have moved to Gibraltar, or Gibraltarians who have previously worked in the UK and transferred their pensions back home.
An investment bond, or a Single Premium Investment-Linked Life Insurance Policy, is essentially a way of holding investments within a life insurance contract (confusing, right?).Individually, both an investment bond and a QROPS have several benefits and, if the client profile is right, they can form part of an effective retirement planning strategy. However, the issue arises when advisers recommend placing an investment bond within a QROPS, which has become an all-too popular structure locally.
The main issue with this structure is that investment bonds are one of the few products that Gibraltar financial advisers can still receive commissions from, and these commissions can be exorbitant. The UK and Spain have both banned advisers receiving commission payments on these types of products. Legislation is in place in both countries which require advisers to publish a transparent fee structure so that clients can negotiate and agree a fee before any work is undertaken.
In Gibraltar, there are two ways in which a financial adviser can be remunerated. They can charge the client an upfront fee or receive a commission from a product provider for introducing the business to them. At first glance, to the client, it may seem as though their adviser receiving a commission works out best for them.
Why? An adviser who receives a commission from a provider may market their services and advice as ‘free of charge’ because there is no direct fee being paid out of the client’s pocket. This is, quite frankly, a deceptive tool used by advisers to sell a product with a high commission.
Insurance-based investment products such as investment bonds can pay up to 10% commission to the introducing adviser. This begs the question, “how do they get paid so much, yet they don’t charge the client anything?”. This is simply because the money is taken from the client’s investment fund and sometimes without their knowledge or approval. This is not only an opaque way of charging clients but, more importantly, it will severely hinder the overall investment performance of their pension. Make no mistake, these commissions are paid back to the provider by the client.
Investment bond providers will include an “Establishment fee or Percentage Administration Fee”(usually around 1%-1.2% per annum) until this commission is reclaimed from the client. The period over which this takes place can vary from 5-10 years.
Another major drawback to these structures is that you are locked in until the commission paying period has elapsed. If a client does want to exit their investment bond before the commission-paying period is completed, they will have to pay the provider any outstanding commission. This is generally displayed as the “Surrender Penalty” and can be a hefty charge to say the least, especially when they didn’t even know it existed.
The second issue, which is linked to the one previously mentioned, is that of overall cost. Adding an investment bond to a pension adds a layer of unnecessary costs to the overall plan. Investment bond charges are notoriously high and once you add on the Establishment Charge (commission payback), and other fees and charges, the overall expense can reach between 1%-1.5%. This means the underlying investment must work even harder before the client sees a profitable return on his pension.
You then must factor in annual QROPS Trustee fees, annual financial advisor fees and annual underlying investment fees. Once these fees have been aggregated, a client could be looking at a Total Expense Ratio of anywhere between 3%-4%. Once clients realise this, they understand just how inefficient these structures are. Sadly, it is often after the event.
To put this into perspective, Abacus Wealth Management will never recommend a structure that has a Total Expense Ratio (TER) of anything above 2% per annum. The company’s target TER is1.5% but there is leeway (up to 2%) when there is a powerful investment proposition that justifies the additional cost. The end result is that clients are left feeling frustrated and deceived as they were hitherto unaware of the commissions being taken and the high charges associated with their pension. To add insult to injury, clients only have recourse against their adviser if this commission wasn’t disclosed to them at the outset, as defined in the Insurance Distribution Regulation (Regulation 20).
However, not all hope is lost as there are ways that advisers can streamline these pension structures to mitigate the effects of high charges and can implement a plan to exit the bond and reinvest into a more cost-effective structure, once these awful and outdated commissions have been paid off.
Daniel Pitaluga, Dip PFS
On behalf of Abacus Wealth Management Limited