Commissions are the main source of income for independent financial advisers in the UK.
When a client goes to an IFA, the IFA will recommend one or more products that are suitable for the client’s circumstances. When the client buys one of these products, the provider will give a commission – usually based on a percentage of the amount the IFA’s client has invested. As a result, IFAs can offer financial advice without their clients handing a penny to them.
This rankles with fee-based IFAs, who charge
clients for their services and often deduct any commissions they receive from the client’s bill. Fee-based IFAs make up less than a fifth of the market.
Antony Williams, a fee-based IFA at Evolve Financial Planning, says: “What really galls us is ‘trail’ commissions. They are fine as long as the IFA is doing something to earn them, but the vast majority do nothing. IFA businesses with a high proportion of trail commission are worth more than those who take mainly upfront commission.”
He adds that in some cases, commission creates bias when advisers are selecting products.
Most mortgages offer procuration fees, which are essentially commission by another name.
But unlike other types of independent financial adviser, many mortgage brokers are fee-based and pass the commission on to the client by knocking it off the bill.
Ray Boulger, senior technical manager at mortgage specialist John Charcol, says a typical commission for a normal mortgage would be about 0.35 per cent of the amount lent. For example, a £200,000 mortgage would generate commission of £700.
But this amount can be increased if, for example, the adviser does a lot of business with one particular lender and can therefore negotiate a higher commission rate. There are also higher rates for certain types of mortgage – for example, a self-certification mortgage generates commission of 0.5 per cent.
A subprime mortgage (where the lender reckons the risk of the borrower defaulting is well above average) generates commission of between 0.5 per cent and 2 per cent, with the riskiest cases generating the highest commission. That means a £200,000 subprime mortgage can generate commission of up to £4,000.
Collective investment schemes such as unit trusts pay an average commission of 3.94 per cent, according to the Financial Services Authority. This includes upfront commission, which can easily be above 1 per cent, and trail commission, which is typically 0.5 per cent a year (of the client’s assets under management) but can be higher.
Some fund managers offer a higher than normal commission rate for a limited period, often when they are launching a new fund. When L&G launched its High Income unit trust in 2001, for example, it offered IFAs either 1 per cent initial commission, or 0.25 per cent initial and 0.25 per cent trail, but only until April 2002.
For a £100,000 investment, that means either £1,000 upfront or £250 upfront and a further £250 for every year the client sticks with the fund. After April 2002, IFAs had a choice between either 1 per cent initial or 0.25 per cent trail.
For regular investment schemes, which typically involve a monthly payment into a fund, the FSA says the average commission is 23.8 per cent of the first year’s payments. For example, if your IFA persuades you to put £200 a month into a UK equities fund, that implies he will receive just under £600 in commission for his efforts.
Funds of funds are offering high levels of commission at present, perhaps because they are a growing asset class and providers are keen to promote the product to IFAs. One leading provider has a total expense ratio (the full amount the customer has to pay) of 2 per cent a year, of which about half goes to the IFA in the form of commission.
In contrast, investment trusts are companies in their own right that offer a similar product to unit trusts but do not pay commission to IFAs. Funnily enough, commission-based IFAs tend not to recommend them very much. There is an adage in the personal finance world that “IFAs put their clients into unit trusts, but buy investment trusts for themselves”.
Commissions for self-invested personal pensions, or Sipps, are similar to those for other investment products such as unit trusts, according to Edward Nice, an adviser at fee-based IFA Syndaxi Financial Planning.
But the percentage paid can be higher. Nice says a typical rate would be 3 per cent upfront and an ongoing rate of 0.5 per cent. So if you set up a Sipp worth £500,000, your adviser could receive a whopping £15,000 straight away, and a further £2,500 every year – the latter is supposed to cover the cost of maintaining your portfolio and updating you on your investments, so make sure you get your money’s worth by demanding a high level of ongoing service.
For term assurance – the simplest form of life insurance, where you insure against death for a fixed period – commission is usually a few hundred pounds.
For example, Nice says that a 34-year-old man who takes out a 24-year policy could pay £7.49 a month, and his beneficiaries would receive £80,000 if he died. This would generate £155.72 in commission, which covers the first four years of the policy.
The IFA must return some of the commission to the insurance provider if the
client cancels the policy within that period.
After four years, the IFA receives 19p a month for the rest of the policy – a period that could last up to 20 years.
For “whole of life” policies which have no fixed term and where the insured person can pay extra premiums that are invested, the same commission principle applies.
However, the IFA can opt for a smaller upfront commission, known as a non-indemnified commission, which cannot be clawed back by the insurer even if the client abandons the policy after a short period.