A peculiarity of the Irish market, allocation rates confuse at best; at worst they can severely hurt savers and investors. <\/p>\n
While there was discussion to ban allocation rates \u2013 a structure that facilitates the payment of commission \u2013 almost 10 years ago, it appears that the issue is off the agenda for now in Ireland. In the UK, allocation rates were banned alongside other forms of commission in 2012 as part of a retail distribution review.<\/p>\n
\u201cWherever you\u2019ve seen a commission ban, this is what they\u2019ve banned,\u201d says David Quinn, managing director of fee-based advisers Investwise Financial Planning, on the subject of allocation rates. \u201cIt\u2019s by far and away the most common charging structure and remuneration method,\u201d he says, adding that the \u201cvast majority\u201d of advisers avail of it to get paid.<\/p>\n
But how exactly do allocation rates work? What does an allocation rate of 105 per cent really mean? And what are the questions you need to ask to make sure you\u2019re getting the best possible outcome?<\/p>\n
In short, an allocation rate means the percentage of your contribution to a pension<\/a> fund or an investment or savings product that actually goes into the fund each month.<\/p>\n So if the rate is 100 per cent, and you contribute \u20ac100 a month, then all of that \u20ac100 should go into the fund. <\/p>\n The Competition and Consumer Protection Commission<\/a> (CCPC) gives the example of an allocation rate of 97 per cent, which \u201cmeans that for every \u20ac100 you invest, \u20ac97 is actually used to buy units. So, in effect you pay \u20ac3 (or 3 per cent) as a charge to the firm you invest with on every \u20ac100 you invest\u201d. <\/p>\n For a \u20ac1,000 investment, that would mean a charge of \u20ac30.<\/p>\n However, while this example is easily understandable, allocation rates are often used in different ways. Rachel McGovern, deputy chief executive of Brokers Ireland<\/a>, says allocation rates need to be \u201cclearly explained to clients\u201d. <\/p>\n \u201cOnce the consumer understands them, that is what is important. They can then make an informed decision on their preferred method of payment, be that an upfront fee or otherwise,\u201d she says.<\/p>\n But do investors and retirement savers always fully understand them?<\/p>\n The practice<\/p>\n \u201cI think it\u2019s smoke and mirrors,\u201d says Steven Barrett of Bluewater Financial Planning.<\/p>\n Indeed. Just because you\u2019re getting a 100 per cent allocation rate \u2013 which is what one would typically expect \u2013 it doesn\u2019t always mean you\u2019re getting the best deal.<\/p>\n Other fees and charges on the product might actually end up costing you more than if you had got a different product with a lower allocation rate.<\/p>\n Some investment products come with charging structures that allow for 105 per cent allocation \u2013 up to 5 per cent of which might go to the adviser. <\/p>\n Some advisers might say that their advice isn\u2019t costing the client anything \u2013 rather it\u2019s coming out of the insurance company\u2019s marketing budget,\u201d Quinn says.<\/p>\n \u201cThat is the key sentence that people trust and accept,\u201d he says. \u201cIt\u2019s most misleading\u201d because, of course, the client will end up paying the commission via a higher management charge.<\/p>\n This means that even if the adviser was to offer you the 5 per cent commission (105 per cent is the maximum allocation), given the higher management fees, you\u2019d likely start to lose money after the seventh year, says Quinn.<\/p>\n Barrett agrees with the comment that it\u2019s never the insurance company that covers the adviser\u2019s fee. <\/p>\n \u201cThe client is paying for it through a higher management fee,\u201d he says.<\/p>\n It means that the money is coming directly out of your investment pot. An investor might be okay with that but the issue is that many people do not fully understand the structure.<\/p>\n \u201cAll of this is disclosed in a very murky way in the documentation,\u201d says Quinn. It is usually phrased that the client is getting 100 per cent allocation, he adds, but on a page towards the back there will be a little box detailing adviser or intermediary remuneration. <\/p>\n \u201cBut a lot of people don\u2019t read it,\u201d says Barrett. And if they do, they see 100 per cent allocation and they expect that it is the insurance company covering the adviser\u2019s commission \u2013 and not their higher annual management charge. <\/p>\n And these higher annual management charges can really bite. <\/p>\n \u201cAllocation rate is a one off \u2013 annual management charges are for the life of the policy,\u201d says Barrett. They come out of your fund every year, eating into your expected growth.<\/p>\n Sometimes, the adviser might split the commission, so that the client gets a 102 per cent allocation for example, and the adviser gets 3 per cent. But again, while there might be an initial uplift, this can be eaten away by higher charges.<\/p>\n You should also beware early exit penalties which can often apply where the allocation rate is in excess of 100 per cent. In some cases, an adviser could take 5 per cent up front and a half per cent trail every year.<\/p>\n \u201cIt\u2019s not unheard of, but it\u2019s pretty extreme,\u201d says Quinn, adding that this could be compounded by switching to a new product provider after five years, and getting the 5 per cent upfront payment again.<\/p>\n While it may not be common, Quinn has seen cases of people with an approved retirement fund (ARF) of \u20ac1 million paying out \u20ac50,000 in upfront commission, or \u20ac100,000 on a \u20ac2 million fund. <\/p>\n \u201cYou wouldn\u2019t pay \u20ac100,000 for a professional fee but yet people can take this commission on a big pension fund, and no one bats an eye lid,\u201d says Quinn.<\/p>\n Reform?<\/p>\n It doesn\u2019t have to be like this. Stockbrokers don\u2019t pay commission on product sales, nor do online brokers, while most of the life companies also offer lower-cost products, known as the \u201cclean pricing\u201d option. <\/p>\n \u201cThere is no payment to the adviser, no encashment penalties and nothing is hidden,\u201d says Quinn. Instead, savers typically pay upfront where advice is given.<\/p>\n So should allocation rates go?<\/p>\n Barrett suggests that everything should start from a base of being 100 per cent allocation, and if fees\/commission are taken from the contribution, then the allocation comes down accordingly. So fees\/commission of 3 per cent would mean that 97 per cent of someone\u2019s contribution goes into their investment \u2013 quite clear for savers\/investors. <\/p>\n Barrett says it is likely that allocation rates will \u201cslowly die a natural death\u201d, given the move away from personal\/executive type pensions, towards PRSA<\/a>s and master trusts.<\/p>\n \u201cThey don\u2019t really do allocation rates in the same way,\u201d he says, although he adds they can still be \u201cvery lucrative\u201d for advisers of ARFs.<\/p>\n And people have become more savvy.<\/p>\n \u201cI think it will be market pressure that changes it, rather than regulators,\u201d says Quinn, adding that he sees younger professionals in particular being more sensitive to such practices, and more willing to pay upfront for advice.<\/p>\n Until then, it\u2019s a case of tread carefully when buying a product where allocation rates might apply.<\/p>\n \u201cI say this to everyone: \u2018You can\u2019t know who\u2019s a good adviser who is working in your best interest, and not trying to maximise fee income out of you.\u2019 So, the question I always say to ask, is will they do it for a fee? If they don\u2019t, I\u2019d be asking a lot more questions,\u201d says Barrett.<\/p>\n Quinn agrees that you have to talk about the money.<\/p>\n \u201cThe key question is to ask the adviser: \u2018What is the cost of advice here?\u2019 Or what is the wholesale price of the product and what is the cost with advice?\u201d he says, adding that you should also query an adviser as to whether or not there is another provider with a similar product that doesn\u2019t pay commission.<\/p>\n \u201cIt cuts through any conflict,\u201d he says.<\/p>\n Allocation rates in practice<\/p>\n