The costs of managing and administering pensions are coming under increasing scrutiny because they can have a significant impact on pension capital. Costs vary widely between different pension solutions, and although comparisons do not paint an accurate picture they can still be of value.
It is natural that pension management and administration come at a price. It costs money to collect contributions, manage pension assets and pay out pensions. Asset management costs are often the largest single cost. Sweden’s state income pension system has relatively low management costs. This is due to a variety of factors, including the fact that the AP funds’ assets account for only 15% of the total capital in the system. Also, the AP funds are cost-effective in their asset management: on average, the funds’ internal operating and external management costs are 0.15% of portfolio value. This is what it costs the funds to manage highly diversified portfolios with multiple types of listed and unlisted assets.
Chalk and cheese, but low costs.
Costs of the AP funds and Swedish Pensions Agency
Costs that are deducted from pension assets are known as administration costs and relate directly to the way the system operates. They include the AP funds’ operating costs, the Swedish Pension Agency’s costs for administering pensions and the pension administration costs of government agencies including the Swedish Tax Agency *. In 2015 AP1, AP2, AP3, AP4 and AP6 had combined costs of SEK 913 million. Administration costs totalled SEK 704 million, giving a total of SEK 1.6 billion. This sum equates to 0.03% of average pension rights and is deducted annually from total pension system capital.
An easy shorthand way to calculate the amount lost to costs is to deduct the fees that accrue during the average time that a pension payment remains in the system before being paid out as a pension **. The Swedish Pensions Agency measures this period for the state income pension at 21 years and for the premium pension at 33 years ***. The longer period for premium pensions reflects the fact that fees continue to be payable while the individual’s pension pot is being paid out.
Low income pension system costs
The state income pension is the solution with the lowest cost ratio – 0.03%. The total cost deducted during the assumed time frame prior to disbursement is less than 1%. In other words, pensioners retain 99% of the value of their pensions after all costs have been subtracted. These figures reflect the system’s design and its low asset management and administration costs.
They can be compared to an assumed premium pension cost of 0.3%, which reduces the pension pot by 9% prior to disbursement. In other words, the individual would retain only 91% of his or her premium pension pot after fees. The rate of return becomes more important if asset management costs are higher. Were a pension saver to buy a pension charging a management fee of 1% a year, his or her pot would fall to 72% of its full value. Costs in this case would eat up more than a quarter of the capital.
*) AP1, AP2, AP3 and AP4 finance all the administration costs of the income pension.
**) 1-(cost)ⁿ where n=average time.
***) Orange Report 2015.