Pension charge caps
17 January 2014
- Steve Webb is right to delay introduction of charge cap – 2014 was too soon
- Cap new scheme charges to protect smaller firms’ workers but leave legacy schemes till after 2018 – and reform NEST charges to allow proper comparison
- Capping annuity charges is far more important anyway!
Sensible decision to delay charge cap: It is good to see that Steve Webb has decided to delay introducing a cap on the charges paid by workers in auto-enrolment pension schemes. April 2014 would have been too soon, as it would have effectively punished employers who selected their scheme in good time ahead of their 2014 staging date and required many to renegotiate their arrangements. Auto-enrolment is a huge headache for most firms and employers do need to prepare early. That means giving fair notice of such fundamental changes.
Need to signal a cap for 2015 perhaps, to protect workers in small firms: Nevertheless, the Government is right to worry that, as auto-enrolment proceeds to include many of the smallest employers, there is a risk that pension charges will rise due to the spike in demand. So far, new auto-enrolment scheme charges are already low, coming in at 1% or less for the Annual Management Charge (AMC). Introducing a cap for future schemes – perhaps signalling a cap starting in 2015 – should help to ensure providers adjust their pricing structures to prepare for the new policy without interfering with scheme choices already made.
Important to adopt a measured approach – ensure no increase in charges for four years on existing schemes: In the near-term, introducing a cap for schemes already set up could interfere with roll-out of auto-enrolment and divert industry resources away when they will be vitally required to service the coming capacity crunch in the industry. Therefore, perhaps there should be a requirement that charges on existing schemes cannot be increased for the first 4 years and then introduce charge caps on schemes already established.
Charges obsession could go too far: Of course, there is no ‘right’ answer to the question of what is a fair fee level and what a cap should be. Charges have already fallen dramatically, which is good news and I believe it is important not to become too obsessed with charges on the accumulation phase of pensions as there is a danger of dumbing down investment approaches by trying to lower fee levels too far, too fast. A 0.75% charge is not a ‘rip-off’ and driving charges down to 0.5% too quickly may hamper innovation in investment approaches for default funds. Just forcing everyone into a passive tracker fund or an inflexible lifestyling approach is not necessarily an optimal investment strategy. Firms have to make enough money for it to be worthwhile innovating.
NEST reforms needed – two tier charge structure makes it hard to compare charges: In any charge cap change, I believe the Government should address the problem of NEST’s high initial charge. Currently, NEST takes 1.8% of each contribution made plus an additional 0.3% of the contribution value each year. For older workers being automatically enrolled into NEST, this amounts to a very high fee level – far greater than any proposed cap. Not only will this be bad value for workers who do not contribute to NEST for many years (for example for those who are close to retirement when they start contributing), but having a two-tier charge structure makes is much more difficult to compare charges across different schemes. It would be much easier for employers and workers to understand the impact of charges on their auto-enrolment pension funds if there was just a single charge, reported in a standard format, which could be compared across all schemes. A flat-rate charge of, say, 0.5% for NEST, would set a good benchmark for the industry.
Capping charges and controlling value for money on annuities is far more urgent: Charges on new pension schemes is not actually the most important problem and is missing a much more important issue. There are no controls at all on the fees charged, or value for money offered, at the other end of the pension system when people can buy poor annuities, which may often be the wrong product at a bad value rate and pay high fees to do so. Far more money is lost from people’s pensions at the point of retirement, than would be saved by reducing charges from, say 1% to 0.75%. The DWP’s figures show that the difference in fund value for an average worker after 46 years of saving is just 5.5%. However, when buying an annuity, workers can lose over 4% in charges in one fell swoop and, if they buy the wrong type of annuity or get a poor rate, they can lose 20%, 30% or even more of their fund.