Which is the best payment option for you? Fees or adviser charges?

Oct 10, 2018 | Tony Byrne's View

If you are investing £100,000 into an investment you may be charged, say, a 3% initial fee and 1% p.a. recurring fee for managing it on an ongoing basis.

Payment by fee or adviser charge (customer agreed remuneration) deducted from the investment is summarised as follows:

Adviser charge (customer agreed remuneration):

Investment of                             £100,000

Less: adviser charge at 3%          (£3,000)

Net investment equal to               £97,000

Fee:

Investment                                             £100,000

Less: fee at 3%(not deducted from plan),   zero

Net investment                                       £100,000

The fee payable is £3,600 (£3,000 plus VAT @ 20%), which means that paying a fee is more expensive by £600 or 20% in this example. However, assuming the fee is payable out of post- Tax and National Insurance income, the real cost of paying by fee is still greater.

For simplicity, National Insurance will be ignored in this example. The extra £600 payable is increased by the tax deducted from income as follows;

Tax rate formula:

The Basic rate Tax payer gets tax deducted at 20% , therefore 100/80 x £600 would incur additional expense of £750;

The Higher rate Tax payer gets tax deducted at 40%, therefore 100/60 x £600 would incur additional expense of £1,000;

The Additional rate Tax payer gets tax deducted at 45%, therefore 100/55 x £600 would incur additional expense of £1,091

So, depending on your rate of Income Tax, your effective fee is increases by £750- £1,091 from the combination of VAT and Income Tax.

Another approach is to simply invest less money and pay the fee instead:

Investment of                                         £97,000

Less: fee @ 3% (not deducted from plan),   zero

Net investment equal to                           £97,000

The fee in this example is £3,492 (investment of £97,000 x fee of 3%, which equal to £2,910 plus VAT at 20% of £582).

Again, for simplicity, National Insurance will be ignored in this example. The extra £582 payable is increased by the tax deducted from income as follows:

Tax rate formula:

The Basic rate Tax payer gets tax deducted at 20% , therefore 100/80 x £582 would incur additional expense of £727;

The Higher rate Tax payer gets tax deducted at 40%, therefore 100/60 x £582 would incur additional expense of £967;

The Additional rate Tax payer gets tax deducted at 45%, therefore 100/55 x £582 would incur additional expense of £1,058.

So, depending on your rate of Income Tax, your effective fee increases by £727- £1,058 from the combination of VAT and Income Tax.

It must be noted that this whole example is based on the assumption that VAT is applied 100% to the fee. The VAT rules on fees for financial services are a little grey. The basic principle is that VAT is chargeable on advice given, but not on simply arranging a transaction, which is exempt from VAT. The problem is, how do you determine, how much of the fee relates to advice and how much to arranging the transaction? I’ll leave that issue for the accountants to debate!

Fees vs adviser charge

To summarise, the effective cost of paying by fee is as follows, depending on your Income Tax rate:

Tax rate             Adviser charge               Actual Fee                     Effective fee

20%                  £3,000                           £3,492- 3,600                 £3,727- 3,750

40%                  £3,000                           £3,492- 3,600                 £3,967- 4,000

45%                  £3,000                           £3,492- 3,600                 £4,058- 4,091

Interestingly, payment in the form of adviser charge is quite a lot cheaper than paying an actual fee. Actual fees are higher than the adviser charge by 16.4%- 20% and effective fees are higher by 24.23%- 36.37%.

If you would like advice from us why not get in touch? You know it makes sense.

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