The world of personal finance is a minefield. If you don’t work in this area or take lots of time to figure out how it works, it can be very confusing and off putting. One of those areas is that of allocation rates. That is, of the money you contribute, how much of that is actually invested? Normal people assume that if you pay in €100,000, that amount will be invested. Did you know that you could actually have more than you paid invested into your pension or investment plan? That’s right, free money!! If you put €100,000 into a pension, you could get a “bonus” of anywhere from 1% to 5% i.e. €1,000 to €5,000 extra.
Initially you don’t understand why you are getting free money and you are right to think so because you are not. Let me show you an example of different contract structures for a pension plan, each with different allocation rates:
| Contract 1 | Contract 2 | Contract 3 | |
| Allocation Rate | 101% | 102% | 105% |
| Annual Management Charge | 0.5% | 0.75% | 1% |
So, you can see that the higher the allocation rate, the higher the annual management charge. This charge is taken against the value of your fund each year and it covers the life companies costs, the allocation rate and some profit. So the cost of the bonus is actually being taken out of your own fund over time. And the longer you keep the money there, the more it costs you. Let’s look at our pension investment of €100,000, growing by 5% gross each year for 10 and 20 years
| Contract 1 | Contract 2 | Contract 3 | |
| Allocation Rate | €101,000 | €102,000 | €105,000 |
| Net Growith | 4.5% | 4.25% | 4% |
| 10 Years | €156,850 | €154,654 | €155,425 |
| 20 Years | €243,583 | €234,488 | €230,068 |
To protect themselves from clients going allocation rate shopping, that is taking the 5% bonus and transferring the €105,000 to another insurer, where they can do it again, there are usually early exit penalties on these contracts. There are typically 5% in year 1, decreasing by 1% each year under after year 5, there are none. And clients hate early exit penalties. When you sign up for a pension or investment, you get tons of paperwork and even if you were specifically told about the exit penalties (which you should be), there’s a good chance you will forget. Besides, when you sign up for a pension, you usually don’t intend in moving it at all. But things happen and it’s usually a few years later you want to move out only to be told that there’s a penalty applied to your money if you do.
Of course, most clients don’t see this extra allocation at all as the adivsor takes it as their fee (full disclosure: Bluewater does take the additional allocation as a method of payment. Not the 5% one though). This can create an obvious conflict of interest when giving advice. There have been cases where someone is retiring with €1m in their pension pot and the advisor has taken the 5% additional allocation for themselves. That’s a €50,000 commission!! There is never €50,000 worth of work in advising someone on their retirement.
Just get rid of allocation rates. If you have €100,000 to invest, you get a 100% allocation rate and a lower annual management fee. If you want to pay the advisor fee from your investment amount, you can choose to do so or you can pay a fee. You should be able to pay it as a percentage or fixed fee if you wish. The likes of Conexim and Quilter Cheviot allow for fixed fees but the main insurance companies are still limited to charges as a percentage of assets.
Let me know what you think by dropping me an email at steven@bluewaterfp.ie