This month marks the start of auto-enrolment, the Government’s flagship pension reforms that aims to eventually get up to 11 million more people saving in a workplace pensions.
The success or failure of the policy will be dictated by people’s willingness to remain in their company pension and so getting public sentiment behind the scheme is of critical importance.
But the launch has been overshadowed by politics with Ed Miliband once again attacking pensions providers by suggesting they are profiteering from pension scheme members.
Legal and General pensions strategy director Adrian Boulding is slightly exasperated by the repeated attacks on supposedly high charging pension schemes.
He says: “We look at the business we sell and we are not selling anything at 1 per cent. Everything we sell is well underneath 1 per cent, so we don’t see what the argument is about.”
Boulding says the fact that politicians are not accurately informed gets in the way of having a serious debate. In July, the last time the Labour party tried to make political capital out of pension charges, Miliband managed to criticise a retail investment fund charging 4 per cent a year, the Neptune UK Mid Cap fund, rather than a pension scheme, and one that had produced handsome returns for its investors. The fund produced 19 per cent last year and around 90 per cent of the last three years.
Boulding says: “They took aim at completely the wrong target. It wasn’t a pension fund and actually delivered an amazingly good deal for its members.
“I wish they would get their facts right.”
Pensions minister Steve Webb has also been using party conference season to make some headlines with his attack on and employee benefit consultants for ‘dissing’ Nest and instead chasing commission from commercial schemes.
Boulding says these comments are wide of the mark.
L&G is a supporter of auto-enrolment and the company has been one of the big early winners from the policy. The UK largest employers have to begin auto-enrolling their employees this month and several, including The Co-Operative, Marks and Spencer and Sainsbury’s, have opted the use L&G to provide their scheme.
Boulding says the decision whether or not to use Nest is a lot more complicated than whether on not commission will be paid. Of much more relevance are issues such as the charging structure of the scheme and the investment structure.
“A lot of advisers are put off by Nest’s charging structure. Nest has gone for the unique charging structure of having two charges, where they take 1.8 per cent off the front of every premium and then a relatively low annual management charge of just 0.3 per cent after that.
“The interesting thing about this is it is going to be good value if you are going to be a long-term contributor into Nest. I’ve done the sums and in my view it is about a 16 year break even point. So 16 years or longer you are going to get good value out of this very low AMC that really starts to benefit your long-term contributions.
“If on the the other hand you are more of a transient worker, you are in one job, out of one, in another one, then it will be rather expensive. That is something that advisers are baring in mind and are saying ‘just how expensive is this front-end charge and is it appropriate for the market we are looking at?’”
Another problem with using a contribution charge is that is will push up opt-out rates as people see the effect immediately in their pension statement.
Boulding says experience has taught L&G that this type of charge can cause scheme members to quickly become disillusioned.
“We gave up having initial charges on our accounts quite some time ago. The reason is you get quite a lot of kick-back from the employee. If you are an employee and you have £100 deducted out of your pay and it has gone into the scheme but only £98.20 is credited to the scheme, you are on the telephone saying, ‘where has my other £1.80 gone?
“Clean schemes that do not have those upfront charges avoid those difficult conversations with the employees.”
But on the subject of charges, Boulding says the most important factor is perhaps the one that is getting the least attention – the issue of active member discounts.
“What are euphemistically referred to as active member discounts. They are nothing of the sort. They are early leaver penalties. These are schemes where there is a low charge for current membership but if you leave the scheme then the charge rockets upwards. In some cases it can double, or even treble. It shouldn’t go upwards, as when you are a leaver and no longer contributing you are a lot less work for the administrator.
“I’ve done pension scheme administration and the hard work is the monthly churn. Every month you have got to take another contribution and bank it and get it onto the policy, update everything, tell the members about. Once you remove that element, the administration requirement goes down and schemes which are substantially increasing the charge with the euphemistically named active member discounts are just profiteering off people who have stopped contributing.”
Boulding is particularly concerned about the effect of active member discounts on people who opt-out of auto-enrolment but not within the first 30 days.
“We are going to see two types of opt-out under auto-enrolment. We are going to see what the DWP calls an opt-out, somebody who within 30 days has said I don’t want to be part of this pensions scheme and they have found the opt-out form and filled it in and sent it back. They are easy, they are very clean to deal with, they just get their money back.
“Then we are going to get a second wave of what technically are not called opt-outs, they are going to be called early-leavers. They will wake up to this when the see their pay packet, and it might be two or three months down the road before the spot the details in the pay packet, and that is the the point that they are going to wake up to the fact that ‘jeepers, I am paying a pension contribution’. “And for whatever reason, if they don’t want to pay a pension contribution they will stop but they will then leave a small pot in that scheme. If that scheme has got active member discounts on it, then that small pot is going to be whacked with these very high charges.”
The issue of small pots is being considered by the DWP and Boulding says he is encouraged by current plans for dealing with the issue.
“The legislation we believe the DWP will be going to craft is based on the principle of assumed members consent. The member will be told by his new pension scheme that it is going to look for any small pots and if it finds them it will bring them across, unless he says please don’t do that. If the member doesn’t respond then consent it assumed. It neatly mirrors the principle of auto-enrolment, where people are being told, we assume you want to join the pension scheme and you will be enrolled unless you tell us otherwise.”
The timing of these reform is far from certain at present. The changes needed to allow pensions pots to automatically follow scheme members is to added to the Pension Bill that had been expected to be introduced next year to reform the state pension. But with David Cameron apparently going cold on the idea of state pension reform before the next election, this would significantly delay any measures to tackle pot follows member for occupation schemes.
Even if the Pensions Bill arrives next year as planned, Boulding says it will be four or five years before we could expect to see a system in place and functioning.
As reform of the state pension is due to remove means-testing, there have been suggestions that this makes selling the idea of auto-enrolment a much harder task. Boulding says any delay or even abandonment of state pension reform would be a setback but not an insurmountable one.
“It makes the job more difficult. This is one of those strange areas that academically, the argument is clearly that one should save. I know the DWP has used its model, called PenSim, and the PenSim model shows that, even with means testing, 99 per cent of savers are going to be better off by being automatically enrolled.
“It is a very different argument when you are actually trying to win over the hearts and minds of the man in the street, when he has a newspaper article which says here is Mrs Exception, who happens to be in that 1 per cent and she hasn’t ended up better off. That then creates a fear that I might be made to look a fool, when actually if I didn’t save, the state would have paid for me anyway. It is more a perception, fear problem, a hearts and minds problem than a real problem because the academic studies show it is not real.”
The education piece of the puzzle is going to be critical not just for the success of auto-enrolment but also to ensure that people actually accumulate sufficient income in retirement. He says everyone in the industry knows auto-enrolment will not provide a decent income by itself but rather than raise the contribution rates, people need to be made aware of this to allow them to make their own arrangements.
Boulding says that for a median earner who auto-enrols over his or her working life, allowing for a few years of missed contributions and reasonable assumptions for investment growth, the auto-enrolment scheme will provide an income of about 15 per cent of final salary. When the state pension is added, the total income is pushed up towards 45 per cent of the median salary at the point of retirement.
“Now that is saying that when I retire, I am going to get just under half what I am currently earning. That doesn’t sound terribly comfortable to me. So we need more than the auto-enrolment level, we need people to understand that and the system that we have gone for, auto-enrolment for everybody but at a low contribution level, what that system means is that each of us can choose at what point in our lifecycle we want to make those extra contributions.”
|Boulding on auto-enrolment:|
Public perception of auto-enrolment: “Generally it is being well received. People have seen the adverts and they like the idea. There are two things they like, they like the idea that it is going to happen to them automatically and they like the idea that employers are going to contribute as well, they like the concept of a shared burden of saving for retirement.”
Criticism of IFAs not using Nest: “A lot of advisers are put off by Nest’s charging structure.”
Active member discounts: “What are euphemistically referred to as active member discounts They are nothing of the sort. They are early leaver penalties. Active member discounts are just profiteering off people who have stopped contributing.”
Politicians and pension charges: “I wish they would get their facts right.”
Increasing the auto-enrolment contribution rate: “I would favour raising peoples awareness instead of increasing the contribution rate. We live in a flexible world nowadays, with flexible working patterns, flexible earnings and flexible careers, so people should be allowed to be grown up enough to decide when they make extra contributions.”
Small pots: “We believe he DWP will introduce a system of automatic transfer, which will move small pots on to your next employer and is likely to base it on the principle of assumed members consent. The member will be told by his new pension scheme that it is going to look for any small pots and if it finds them it will bring them across, unless he says please don’t do that.”