Newcastle 2001 – my stag trip was an interesting affair. The best man thought it would be funny to see how many strangers he could handcuff me to. Not all at the same time mind you – he had some degree of decency.
It was a night that also tested my alcohol capacity to the limit. Today’s proposal from the FCA to introduce a 1 per cent cap on early exit penalties reminded me of some of the emotions I experienced that weekend.
The 1 per cent cap is certainly a step in the right direction, but it still means that many people will be handcuffed to something that is of little use to their current circumstances. Rather like consuming 10 pints of lager, it’s a situation that leaves you with the disconcerting sense of taking one step forwards and several steps back.
Cards on the table – a cap is clearly better than nothing. But why 1 per cent, and why just when someone wants to access pension freedoms? I can’t see how any of it can be rationalised alongside a 5 per cent early exit penalty on the new Lifetime Isa.
The justification given for early exit penalties is that they cover the initial costs incurred by the provider when setting up the policy, and that these are spread across the agreed life of the contract. Having worked for companies that marketed those products, I can assure you that elements of this are open to challenge.
I have said many times that you must question whether it is reasonable to still be collecting charges for events that may have happened around a quarter of a century ago. I’ve also questioned whether these exit penalties really do relate exclusively to initial set up costs, or whether they are actually about ongoing provider profitability.
In reality, the cost was baked into the contract many years ago to ensure the product was profitable over a range of customer circumstances.
The world has moved on significantly since these products were designed. Back then it was the norm to have a fixed retirement date that was usually fairly closely aligned with the state retirement age. People worked until around then and the theory is they could retire to put their feet up.
Today, life is much more flexible. The concept of a standard retirement age has gone, yet people are still locked into contracts based on a decision they made about their retirement date 30 years ago.
Thinking back to Newcastle in 2001, I’m sure some of the folks who reluctantly consented to being handcuffed to a jovial – if slightly tipsy – stag early on in the night could sort of see the funny side. If they’d still been attached to the gibbering, useless wreck I became four hours later, their patience would almost certainly have evaporated. It might have been humorous but it just wouldn’t have been fair.
Nowadays, of course, we also have pension freedoms, which have changed the concept of how you can access your pension savings beyond all recognition from five years ago, let alone 30.
So, regulation to address these inconsistencies is welcome, but why 1 per cent?
The challenge of a percentage-based charge is it introduces an element of cross subsidy. The work involved in arranging a transfer has a cost. What you run the risk of is larger cases cross subsidising smaller cases.
We have seen instances in other areas of the market where cross subsidies of charges have been frowned upon by the regulator. This could be addressed by including a monetary minimum and maximum charge but, better still, the cap could be set at 0 per cent for all policies.
The 1 per cent also flies in the face of the new Lifetime Isa proposals so publicly heralded by the Chancellor. The irony and inconsistency will not escape many in the industry. On the one hand we have a proposal to set early exit fees on pensions at 1 per cent, and at exactly the same time we have a proposal to introduce an early exit penalty on Lifetime ISAs of 5 per cent.
Like my ill-advised trip to the Tuxedo Princess (a bar on a boat), this was undoubtedly a backwards step.
Any charge simply to access your own money is unfair. Charges should relate clearly to the work providers need to carry out for the customer today, and should be commensurate with that work. It is then obvious what the customer is paying the charge for, and whether the charge is fair and reasonable.
In addition, it appears that the proposed cap will only apply to contracts that are preventing people from exercising the pension freedoms. This feels too restrictive. If we are going to address the issue of early access fees properly, the new rules should be applied to any contract that has an exit fee based on an artificial retirement or maturity date, particularly as these dates were often agreed decades ago when the individual had no clue about when they were actually going to retire. Leaving it structured around access to the pension freedoms will leave many individuals handcuffed against their will.
Anyone in an old private pension scheme that is likely to be expensive and inflexible compared to newer schemes should be able to transfer without penalty, regardless of their age. A reasonable fee for processing the transfer is fine, but a percentage charge simply for accessing the fund and based on its size is stopping people from making the most of their pension savings.
Today’s paper from the FCA is progress, but taking bigger steps now could consign the unwanted hangover of early exit penalties to the scrapheap for good.
And believe me, I know all about unwanted hangovers.
Billy Mackay is marketing director at AJ Bell.