'Free' commission-based service can be costly

Choose the wrong payment method - or the wrong financial adviser - and people lucky enough to be classed as high-net-worth individuals may find their pockets are slightly less bulging than they could have been.

According to Mr Ian Mitchell, managing director of authorised adviser Burns & Mitchell, one client made a saving of €12,000 by surrendering an insurance bond with an insurance company, then putting the money straight back into the same fund with the same provider.

The reason? Mr Mitchell negotiated lower annual management charges on the unit-linked managed bond by sacrificing the commission that would normally be paid to him and charging the client on a fee basis instead.

"At the moment, the cost of providing the commission is actually what drives up the annual management charge," he explains.

"The sad truth is that clients of commission-based advisers can be paying the cost of commission for years," he says. "So-called 'free' commission-based advice can come with a high price tag."

In this case, detailed illustrations given to the client by the provider's actuaries showed that his fund of €388,000 would, assuming growth of 6 per cent per annum, be worth a net €479,000 in five years' time in the new bond, as opposed to the €467,000 it would have been worth had he left it in the old bond.

By negotiating savings in the annual management charges on this and three other bonds, Mr Mitchell was able to "transfer" around €30,000 over five years from the pockets of the client's investment managers back into his funds.

The savings on the annual management charge ranged from 0.47 per cent to 0.95 per cent, depending on the providers involved. Providers agree to the lower charges because they are afraid the intermediary will take his or her clients' money and place it elsewhere.

If a financial adviser secures a 1 per cent lower annual management charge on a unit-linked managed product, the apparently steep €350 or €400 an hour charge for financial advice will suddenly seem like a pittance to pay for an individual with six-figure sums to invest.

"On investments with a value of a quarter of a million, it is unlikely that the fee would be more than €3,000 or €4,000," Mr Mitchell says. "If you are paying a 1 per cent higher annual management charge, over 10 years, you will have paid €25,000 extra."

Mr Mitchell compares the commission system to borrowing €3,000 and finding out it will cost €25,000 to repay. "That's crazy, you wouldn't do that."

The switching process is not always a good idea, however. "If the client is going to need the money within years one to five, it is not worth doing because of the surrender penalties," he explains.

Switching out and in again to benefit from lower charges means rewriting the investment, so that the early exit penalties that applied in years one to five of the investment kick in once more.

The process may not be suitable for certain investments, such as with-profit bonds. Providers frequently apply exit penalties known as market value adjustments (MVAs).

"Even without the MVAs, you might be jeopardising the terminal bonus, because it is calculated by the length of the investment term. It's a hard one to quantify," says Mr Mitchell.

But, most importantly, the rewriting process only makes sense for people with holdings of more than €250,000 in insurance bonds, he says. Otherwise the savings are marginal.