The Retail Distribution Review (RDR) was implemented on December 31, 2012 and the financial services industry has undergone a number of changes as a result.
For individual investors the most significant aspect of the review has been the way in which advisers charge for their advice. The principal aim of the RDR in this regard was to make the remuneration of advisers more transparent and this is certainly a positive thing.
Prior to the RDR the cost of financial advice was characterised by the payment of commission. Under the old system investments would be subject to an initial commission, paid to the adviser by the product provider in exchange for recommending the product. For example if you were to invest £50,000 subject to five per cent initial commission, £2,500 would be paid to the financial adviser leaving the remaining £47,500 to be invested.
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The invested fund would then be subject to an annual management charge (AMC), generally equivalent to 1.5 per cent of the fund’s value. Assuming an invested amount of £100,000, £1,500 would be deducted to cover the AMC. This charge would be split in a way that was not particularly clear to the client.
A proportion of the AMC would have been used to remunerate the manager for the running of the fund with a further part being paid to the platform provider. The last segment – approximately 0.5 per cent – would then be paid as trail commission to the financial adviser.
The regulator was concerned that some advisers were receiving this without reviewing their client’s portfolios on a regular basis. This led to the banning of trail commission payments to advisers for any business written after December 31 2012.
The RDR marked a dramatic shift and adviser remuneration is now inextricably linked to the service given to the client. Advisers now have to explain their charges to the client and agree a fee in advance of any advice being given.
Clients have the option of paying a fixed fee or having the cost of advice deducted directly from their investment. Alternatively an adviser may choose to be remunerated by way of an hourly rate or a fee based on a percentage of the investment.
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Following the abolition of trail commission for new business, financial advisers can now only receive an ongoing fee if they regularly review a client’s holdings.
It may be agreed that in exchange for annual reviews of a client’s portfolio 0.5 per cent be deducted from the value of investments each year. Advisers must ensure that their charges are competitive and that the value of their service is clearly communicated to clients.
With a view to creating cost transparency a key aspect of the RDR has been the introduction of clean share classes. These are a brand new type of share class, free of both commission and platform charges, representing only the costs of fund management. For example an old style AMC of 1.5 per cent might have comprised 0.25 per cent for the platform, 0.5 per cent trail commission with 0.75 per cent being paid to the fund manager. The clean share class’ charge would be 0.75 per cent. Any additional charges - such as those for ongoing advice - would have to be agreed with the client.
Clean share classes are the best choice for those wishing to make the cost of advice as clear as possible for the client and many providers have fully embraced the new system. However remnants of the pre-RDR environment still exist and these have been scrutinised by HMRC in recent weeks.
Some providers have continued to use the old system of bundled charges but are getting around the trail commission ban by rebating it to the client.
If we again take the previous example of a 1.5 per cent AMC, the 0.5 per cent trail commission would be paid to the client rather than to the adviser. The providers that have taken this approach argue that they can achieve better value for their clients through negotiation of the level of these rebates. However a recent HMRC decision to tax the rebates as income has made this method much less attractive.
With effect from April 6 last month any such rebates to the client will be subject to income tax at the investor’s marginal rate.
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It is expected that most providers will automatically deduct basic rate tax from future payments of this type leaving higher and additional rate taxpayers to pay the excess via self-assessment.
The value of using bundled charging in this way was already questionable and HMRC’s decision will encourage more providers to consider clean share classes. Individual investors should look to follow suit.
* Trevor Law is a director with Merito Financial Services, chartered financial planners, based in Solihull. E-mail: tilaw@meritofs.com