Discounted Gift Trust-Fees/commissions, effect of deductions

[Jem]

I recognise this is a controversial topic!

I recently met with an IFA who operates via a wealth management co. They sent a proposal on a £500k DGT contribution which set out fees/commissionss and showed the effects of deductions in what I assume is a FSA preset way.

Over the lifetime of the policy, for example 10 years, it shows estimated deductions of £118k to cover commmission, expenses, early surrender fees,charges etc etc. Within this cost is also the charge for "arranging the plan, providing ongoing servicing throughout its term, which has been valued at £30240.00 in the first year, followed by a variable amount depending on the value of your fund. For example, if the value of your fund grows at x% a year then the amounts would be £x in the second year and £x in the tenth year.These amounts are paid out of the deductions shown and are included in the illustrations above. They depend on the size of the contribution, the term of the plan and the value of your fund".

I thought the FSA had tried to make ensure IFA's clarified their costs and charges but to me this only serves to fog it all up again. The reason I say this is that the documentation says that if the policy is surrendered early there is an early surrensder charge. Fine, but why include it within the estimated deductions as if you dont surrender early it doesnt apply. Why not show it separately as I have no idea how much they have allowed and if it is excluded I then can see a more realistic effect/cost of the service.

This particular IFA is tied to the wealth manager who has their own range of funds and so these costs include their administrative charges. Personally I find £30k in the first year steep as along with the trail commission thats c£60k in fees or am I not being realistic having used a combination of fee based and commission from an independent IFA in the past.

[Arnold Aaron]

The 'proposal' or illustration as it is called is a very confusing document.

The 'effect of deductions to date' is not what is physically taken from your investment.

What it means is if the charge deducted was then invested that's what it would be worth in 10 yrs time etc.

i.e. your investment is less by x amount because of the amount they took on day 1 in charges.

In my opinion this is a completely fruitless exercise - all one wants to know is how much they actually deduct from the investment, but, these are the FSA rules on how the charges are 'illustrated'.

[Jem]

Aaron

Agreed. It is v confusing and doesnt serve the general public well enough; and most probably paints an incorrect picture of IFA's.

Having said that £100k+ deductions effect, and £30k 1st year 'fee' for lifetime servicing and commission seems excessive or do you consider that representative/fair.

[Arnold Aaron]

I would pay more attention to how much is actually being deducted from the investment in the form of initial charges, bid-ofer spread etc. and what the annual management charge of the provider is.

For an onshore arrangement, typically this should be no more than 3% initial charge/bid-offer spread on an investment of £500k, and the annual management charge from the provider should be no more than 1% p.a. This should be on a NO EXIT penalty basis. This should of course be with a good range of funds, (at the very least least 180 funds).

The IFA should be upfront about these costs, and should not simply hide it within the illustration.

There should also be an option to pay NO INITIAL CHARGE and a staggered set up charge over say 5 yrs, amounting to no more than 3%, but with an early surrender charge.

I know of one onshore provider (whom I use very frequently) who levies NO initial charge, and NO staggered set up charge, but with an exit penalty within the first 5 yrs only.

In any case one cannot cash in the fund until the settlor has died, so I normally suggest this latter option for many clients, though they always have the choice depending on their circumstances. i.e. one of the beneficiaries might not be in a good financial situation, so would need the money immediately on death of parent, so would not want to have to pay an exit penalty.

Arnold Aaron
Partner, Openwork
www.arnoldaaron.co.uk
e mail: arnold@arnoldaaron.co.uk
Tel: 020 8201 6574 Mobile: 07957 440 724

[Arnold Aaron]

As a side issue, I'm asuming your advisor has thoroughly taken you whether a bare or a discretionary Trust is most appropriate and very importantly discussed with you, that the discount factor is a function of health of the settlor, and that it must be underwritten by a medical reference from the GP at the very least.

[Christian Ward]

A £30k initial fee does seem expensive to me. However, it is important to be clear what you are paying to the life company and what you are paying to your adviser. The adviser's fee should always reflect the amount and quality of advice provided. This applies equally to any ongoing payments to your adviser. This is one of the benefits of operating on a fee basis as there is clarity over the advisers fees as well as the knowledge that the adviser is free to use the company that offers the best solution. This is imperative when considering long-term planning such as DGTs.

In my mind your adviser should be covering the points that you raise re tax and offshore/onshore bonds as part of the advisory process.

[Jem]

Aaron/Chris

We will be taking up the issue of the initial fee and who is getting what for what. Even 1% of 500k for prehaps two meetings and supervising some paperwork is alot!! As I said the FSA should be ensuring that these amounts are made clearer otherwise the public will not get the transparency reqd. With regards to the type of trust I am aware of the difference anyway and there is no plan to change beneficaries

As to management charges I would have thought 1% low but you will have greater knowledge given that there might also be individual fund manager annual charges too. It may be that some providers though are taking advantage of presumed difficulties. In the end I am prepared to pay a little more to have access to both more genral funds + broader range of funds run by established fund managers rather than suites of funds that are more general in nature - a little bit of everything with either a bias towards the UK or USA on the bais that performance might hold up better.

[Jem]

Aaron

Re annual management charges, thank you for the Trustnet link in your other reply. Very useful as you can compare different providers funds which use the same fund managers very simply and see that one provider has a 0% charge whereas another charges nearly 2.50% for the same fund!

As that is levied each year on each funds overall value that's a whopping amount 'taken out' of overall value of the investment each year which over a 10 year period amounts to £120k if the overall fund value only grew to replace the income taken out .

[Christian Ward]

Jem

There is no doubt the FSA prescribed illustration format is not perfect, but it does create a level playing field to compare each provider. The main problem I have is the vast array of different charging options that are available from many providers. Allocation rates, initial charges, bid/offer spreads, establishment fees, surrender charges, advsiers fees, AMCs etc. This makes it very hard, even for a professional, to evaluate the true costs. Great care needs to be taken when looking at individual fund costs. Personally I do not tend to use the provider's fund range at all as I manage the investments on behalf of clients and this translates to no initial fund fees and low institutional AMC rates. Having said that it is highly unlikely the overall fees for the DGT, adviser and funds will be lower than 1% p.a. I prefer bonds which do not charge a % p.a. fee, but a fixed cash amount and this virtually always produces lower fees for larger investments (£250k +) which are likely to stay invested for long periods of time.

You should also bear in mind the additional hidden fees at fund level. Total Expense Ratios (TERs) and Portfolio Turnover Rates (PTRs) help you understand the whole picture of a fund's true cost.