Let’s hope this is the end of trailing commissions

Superannuation accounts with entry fees, commissions paid to advisers, high yearly fees and poorly disclosed exit fees still exist.

In an overhang from the old days, superannuation accounts with entry fees, commissions paid to advisers, high yearly fees and poorly disclosed exit fees still litter the retirement savings landscape. But in a pre-emptive strike before the royal commission rules on the issue, Westpac-owned BT Financial Advice group has scrapped trailing commissions to advisers.

It’s a smart move and hopefully other big players in financial advice will follow suit.

Over 10 years ago on my first day as a young financial adviser in a suburban Godfrey Pembroke practice, I found a large pile of glossy booklets on my desk. They were product disclosure statements for MLC products and my task was to familiarise myself with the approved product range before heading out into the world of advising. In reading these documents, what took my interest was the difference between two versions of one particular superannuation product. One paid an ongoing trailing commission to the financial planner who set it up and the other was commission-free. All other features and options were identical.

The commission version of the super fund incurred a 2 per cent per annum administration fee and paid a trailing commission to the financial adviser of between 0.44 to 0.66 per cent per annum depending on the account size. The commission-free version had an administration fee of about 1 per cent. When I asked my boss why any financial planner would recommend the higher fee super account rather than use the commission-free version and charge an advisory fee, his response was eye-opening.

We used only the commission-free version and charged a separate advisory fee but my boss said some financial planners were not as confident as we were in discussing and charging financial advisory fees to clients and found it easier to have a trailing commission paid to them directly by the product provider.

This trailing commission would not be easily discovered by the client unless they read the fine print or rang the super provider and queried the item. The commission would not show up on the client’s annual statement and would be paid each year, as long as the client kept their super account open.

To put it another way, the big banks had manufactured products that charged higher fees that gave them more profits, and enticed financial planners to recommend them to clients by dangling juicy trailing commissions in front of them.

Fast forward to July 1, 2013 and the federal government brought in the future of financial advice (FOFA) reforms that banned advisers from recommending these commission-based super products from that point forward. Although in a major concession, after strong lobbying from the Financial Planning Association and the banks, trailing commissions were ‘grandfathered’: Financial planners were allowed to keep receiving trailing commissions into the future on super products established before July 1, 2013.

The result of this grandfathering provision was many financial planning businesses quarantined clients who had trailing commission super accounts. As there was no legal requirement to give these clients service, many firms thought the best thing to do would be to avoid contact with these clients at all costs.

They knew that any contact with the client might lead to a discussion on reviewing of super accounts, something the adviser might not want to do, as they would lose their trailing commission if the client moved to a cheaper product.

The federal government also introduced a best interest duty requirement for financial planners to help combat this anti-competitive behaviour. This clause legally bound financial planners to provide financial advice that was in their client’s best interest and could lead financial planners recommending that their clients move to cheaper, commission-free products.

However, just a few months ago, the banking royal commission got an insight as to what progress has been made in the five years since FOFA when AMP financial advice head Jack Regan told the royal commission that 60 to 70 per cent of the fees paid to their financial planners were commissions rather than fees for service.

The Productivity Commission last year also found that there were more than 630,000 super accounts still incurring trailing commissions. Against this background it is healthy to see BT moving to scrap trailing commissions and other arrangements that could be conflicted remuneration.

The move will help 140,000 clients and should be in operation by October: The group says it will initially cost $14 million in the half year and customers should be better off by between $51 and $1000 a year. But there are still about half a million Australians who probably don’t know they are in a highly uncompetitive super fund, and that a financial planner, who in many cases they’ve never met, has been generating a commission from their super account.

Let’s hope this is the beginning of the end for trailing commissions.

James Gerrard is the principal of Sydney financial planning firm FinancialAdvisor.com.au.