Independent Financial Adviser - Paying For Advice

Paying For Advice

Some financial advice is about investments and pensions: and some of these are 'financial products' packaged and marketed by financial institutions: and most of them pay commission. In the UK it is common for IFAs to limit the advice they give to commission-paying financial products. Traditionally IFAs have relied upon commission to pay for their services. In recent years there has been a shift towards fee based advice as this is perceived as fairer toward the client. However, due to under-capitalisation in the advice sector and consumer reluctance to pay for advice on which financial product to buy, the transition to fee based advice by IFAs has been slow and concentrated in the 'high net worth sector'.

The FSA has introduced a new disclosure regime for advisers giving regulated investment advice on retail financial products. Since July 2005 this regime insists that advisers who market themselves as independent must offer the option of paying a fee for advice on which 'appropriate' financial product to buy. The four main remuneration options available for financial advisors are as follows:

• Commission: Traditionally the most common way to pay for advice on financial products is for the IFA to receive a commission from the product provider. The amount of commission must be disclosed, and some IFAs will rebate a portion of their commission, particularly in Execution-Only cases. The amount of commission and whether it is deducted from the amount actually invested or is included in the cost of the investment varies from product to product. The client pays for commission from product charges. As well as the initial commission, the adviser is likely to be also paid an annual "trail" commission by the product provider. Not all products offer the same rate of trail commission and therefore a potential conflict of interest may arise. The products making the highest management charges usually offer the adviser the highest trail commission. Financial products paying any trail commission will usually carry higher annual charges than investments which do not.

• Fees: Less common than commission, IFAs must offer the option of giving advice on financial products by working for a fee. The IFA is not bound by FSA regulations to include advice on those investments and pensions which do not pay commission. Depending on the size and type of the investment, and the complexity of the advice, paying an IFA by way of a fee can work out cheaper than paying commission. Paying a fee for advice can mean that the IFA is not influenced to recommend one packaged product over another simply because one pays more initial commission than another.

• Combination: It is also possible to pay a combination of fees and commission. In this situation the IFA may rebate a proportion of the commission they would have been due, or they may charge fees for advice and commission for transactions.

• Fee-Only: In economies that have developed financial planning (e.g. the USA, Canada, Holland) the phrase fee-only refers to a method of advice where the advising firm receives no commission at all and is paid entirely by individual. Unfortunately the Financial Services Authority uses the term in the context where it is clear the advising firm may also accept commission (referred to above as 'Fees' and 'Combination'). Financial advisory firms in the UK that are fee-only in the international definition contend that paying for advice from a firm which accepts commission will cause a conflict of interests.

There are requirements for the type and amount of payments to IFAs to be clearly disclosed, so it would normally be easy to determine the cheapest option for a particular commission-paying financial product such as an investment.

Marketing costs such as commission increase the annual charges on financial products by a significant amount (ref: Sandler Review).