In January 2014, Pensions Minister Steve Webb confirmed he would delay introducing measures to tackle high charges in workplace pension schemes by a year. Originally he had planned to implement a pension charge cap from April 2014. The minister said: “Nothing has changed our view that action is needed to ensure people are not ripped off by excessive pension charges.” However on 24 February in a written ministerial statement, released by the DWP, Steve Webb said the government will be introducing new measures into the Pensions Bill to ensure transparency in transaction charges and value for money from pension savings.
This U turn was bought about by a rebellion led by former Chancellor Lord Lawson who threatened his own amendment. The original cap on pension charges was only expected to be on new auto enrolment default funds in which there is comparatively little money. It would have ignored the existing high and hidden charge issues that affect many thousands of pre auto enrolment company pensions. The intention now is that the huge legacy problem should be addressed although with the general election looming next year, who knows?
Although costs may be reviewed across the board newer pension schemes do tend to have lower charges on average than their older counterparts. It is in older pension arrangements that high charges continue, and although some charges are unclear, some are completely hidden. These existing high and hidden charges on current pension schemes were not covered in the 2013 consultation on the subject and would have continued under the original pension cap intentions.
For validation of hidden charges see the OFT’s report ‘Defined contribution workplace pension market study’, page 18, paragraph 1.16, available at http://www.oft.gov.uk/shared_oft/market-studies/oft1505. Polly Toynbee picks this up in The Guardian of 24 January 2014 where she writes, ‘Steve Webb, the pensions minister, backed away from capping the charges imposed by pension funds, most of them secret’ (see http://gu.com/p/3m629).
Watch out on Auto Enrolment
Something to watch out for is that if your Auto Enrolment scheme is a continuation of a previous arrangement, it could still be levying high and hidden charges. Charges are very important – arguably more important than the type of pension fund you have in the scheme.
The OFT points out that employees are unlikely to benefit from falling costs on newer (Auto Enrolment) schemes unless their employer changes provider, or is able to use the threat of switching to renegotiate terms. The retail distribution review (RDR) protects against commission charges from January 2013; however, if you continue the same pension scheme, the commission is allowed to continue and RDR is thwarted.
Commission was a large part of the high charging bad old days the authorities are trying to eradicate. For example, a 2 percent annual fee may have seemed okay every year when your company pension scheme was growing to, say, £5m, but what about when it reached, say, £20m or £50m?* Was the service still worth it? What would your employees think when they realised these amounts had to come out of their pension fund savings?
Compounding of charges
Although charges expressed as a percentage can seem trivial, they are not. When applied to the pension account value, or the assets under management (to use the industry term), even a 1 per cent charge can erode 25 percent of the pension fund.
The Pension Institute at Cass Business School (http://www.pensions-institute.org) showed that someone who saves all their working life loses about a third of the pension pot they build up with an annual deduction of 1.5%. The loss is about a quarter with a 1% charge, a fifth with 0.75% charge and an eighth with a 0.5% charge. If you put amounts of money to this, it is clearly an extremely important issue and can make the difference between a good living in retirement and a poor one.
Here’s how it can affect you in real terms: if your pension fund had built up to £100,000 it could have been worth around £133,000 and bought an annuity one-third bigger if the overall charges on the fund had been 1% less. That is, a £6,600 pension per year instead of £5,000 per year. **
It’s not the AMC
If you think your annual management charge (AMC) is the key figure, this is not the case. You need to look not just at the AMC that comes directly from the individual’s account value, but also the further charges that come out of the fund as a whole. These still have a direct impact on the investor. More important than the AMC is the total expense ratio (TER) of the fund, which may not be disclosed in some of the pension documentation even where the AMC is. As far as hidden charges are concerned, of course we don’t know how high these are – but a further 1% may be a fair assumption in more active funds because dealing charges are not within the TER.
If you want to follow through and do some due diligence on your pension scheme I’ve listed some action points below:
If you would like to contact me about any company pension issues, or would like help unravelling the complexity, please phone 07975 979233, or email firstname.lastname@example.org.
*2% charge x £5m pension fund = £100,000 commission per year; 2% charge x £20m pension fund = £400,000 commission per year; 2% x £50m pension fund = £1m commission per year.
** This example is simplified and for illustrative purposes only, and must not be relied upon for any personal or actuarial calculations.
The Office of Fair Trading’s report (OFT1505 Sept 2013) is available at http://www.oft.gov.uk/shared_oft/market-studies/oft1505