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Emma Simon: The pension charges punch-up

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The big fight in the pensions arena is now focused on how low a charge cap should go.

In the Blue Corner, is consumer champion Ros Altmann, flanked by the self-styled “pensions monkey” Tom McPhail.

They argue that lowering charges too far and too fast could stifle innovation in the pensions market and lead to “dumbed down” investment strategies. They also claim it also shifts the focus away from annuity reform, which has the potential to deliver far more significant gains for consumers.

Opposing them in the Red Corner is another consumer heavyweight, Mick McAteer, formerly of Which? and now director of The Financial Inclusion Centre.  

In an unlikely paring with L&G, he argues that reducing a 0.75 per cent cap on workplace pensions to 0.5 per cent – or lower – is the only guaranteed way of delivering better value pensions to consumers.

McAteer says there is no evidence that higher charging, more complex investment strategies produce higher returns over the longer term. “It’s better to focus on lower charges and better returns, rather than alchemy (sorry innovation).”

The fight is now on to see which argument will hold sway with the Department of Work & Pensions, currently holding a consultation on workplace pension charges.

It strikes me that there are a few wayward punches here, that aren’t always connecting. Altmann points to the DWP’s own figures which show that reducing charges from 0.75 per cent to 0.5 per cent a year, will boost your pension pot by 5 per cent – after 46 years’ of contributions. In contrast those retiring could get up to a third bigger pension if employers were required to help them shop around for the best annuity deal.

These figures certainly have impact. Far more needs to be done to ensure employers, and pension providers, help consumers get the most appropriate product at retirement.

But does this have to be at the expense of lower cost pensions during your working life?

In fact, I am not sure whether these figures don’t undermine the arguments about innovation. Given this small margin of difference, I wonder what “innovations” are possible at a 0.75 per cent charge, that can’t be delivered for 0.5 per cent? Does this simply mean you will not be able to include actively managed funds at the lower fee? 

If the lower cap is introduced you may not be able to offer smaller company Japanese funds, “star manager” vehicles, or investments in “alternative” assets within a workplace pension. But are the vast majority of those going into auto-enrollment really going to be worse off as a result? Many would argue that ultra-low charges will force pension providers to concentrate on low-cost passive funds, which is no bad thing.

McPhail argues that getting people engaged with pensions – paying in more, for longer periods of time – will have the biggest impact on overall returns. Again I do not disagree with him. But while you cannot legislate to improve this (aside from compulsory contributions) you can legislate to lower charges. And surely getting people to pay more into cheaper pensions, means even bigger returns.

At the crux of the matter is whether you believe the higher charge will mean a greater range of funds delivering higher returns, and/or thriving businesses that will drive this member engagement. Of course there’s a third option: it just means more profitable pension companies.

Individuals can still invest in “innovative” Enterprise Investment Schemes, property portfolios, the next Neil Woodford – or god forbid – Bitcoins – through a Sipp. But I don’t think this is a suitable strategy for a workplace pension, that will now scoop up the low paid, the unsophisticated and those with little else in the way of long term savings.

Keeping charges as low as possible should to be a priority, alongside targeted help at retirement and better education about pensions. Together these could deliver a knock out punch that would shake-up the next generation’s pension prospects.

Emma Simon is a freelance journalist

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Comments

There are 3 comments at the moment, we would love to hear your opinion too.

  1. I hope all advisers boycott L&G for adopting a blatant self-interest approach without a care in the world of the damage it will do to employers

  2. Surely it’s a matter of offering a reasonable choice – a ‘base’ tracker solution with a charge of 0.5% doesn’t sound unreasonable but I suspect L&G have a strong starting point given their range of in house trackers – that alongside an ‘active’ fund and a shariah fund wouldn’t (IMHO) be excessive.

    I think simplicity is key with AE – the majority will be joining on an unadvised basis and therefore I feel that simple and straight forward investment options are important in ensuring investors aren’t alienated.

    Whilst costs are important, so is value – the last thing needed is a race to the bottom and firms pulling out of the market due to them being asked to meet charge caps which are unsustainable.

    Unfortunately, vested interests will always play out and it’s the deeision makers who need to see through these issues and come up with something if fair value to consumers whilst also enabling sustainability for providers.

    Whaterver that is, IMHO it’s not for the providers to say……….

  3. Emma,
    Clearly the principle of driving charges lower is a good one, and one which has helped to largely rid the market of high bid/offer spreads, nil allocation periods, high early transfer penalties, unseen monthly charges, and one which has helped create an environment which has seen annual management charges reduce for all but a minority of funds.
    However, a charge cap would create a distorted market, where legislation dictates the maximum price rather than a combination of production costs, service levels, profit margin and supply and demand.
    And whilst L & G have been going for many years, they do not have a great record of being right about charge caps. It was they who were in the vanguard creating a maximum charge of 1% for Stakeholder pensions, subsequently raised to 1.5% for the first ten years. This did indeed help shed a lot of the fat in pension charges, and this did contribute to a better deal for consumers in terms of price. However it also reduced the levels of customer service for clients and advisers alike, and interestingly there was no real increase at all in the take up of pensions. It also led to a restricted choice of funds for Stakeholder pensions, but interestingly the freedom for providers to produce higher charging products also led to the development of a new breed of Group Personal Pensions. In addition to the range of “vanilla funds” there was the option to pay more for specialist funds. I cannot see why consumers should be forced to endure a maximum charge cap and the lack of choice that brings.
    You also ask whether a cap of 0.75% would enable greater choice and innovation than a cap of 0.50%. Are you being provocative? Of course it would. But please do not take the discussion down the road of it’s either a cap of 0.50% or a cap of 0.75%. That is not the case at all, regardless of how loud Mick McAteer shouts. Although there almost certainly will be a charge cap imposed by legislation, it is still not a done deal, and even if it is the current suggested alternatives include a possible 0.75% cap with the option to explain why the charge should go as high as 1%.
    To be honest, though the main impact of a legislated maximum cap would be if it were applied retrospectively to existing pension schemes.
    There are existing pension schemes in place where the annual management charge is in excess of 0.75% (and possibly in excess of 1% although this is less likely) but where this charge covers the cost of providing advice to members. So there are schemes in place which have possibly higher charges but which enable the pension provider to then fund the cost of member advice rather than the employer having to pay adviser fees themselves. If these schemes have to be unravelled there is a danger that a) there will not be capacity to re-write these schemes without affecting the ability to meet the demands of new auto-enrolment schemes or b) employers will fund advice costs by reducing employer contributions or c) remove the provision of advice for members.
    The impact on the ability of the pension industry to provide sufficient capacity for the wealth of new schemes will be severely compromised if these otherwise perfectly good schemes are forced to be re-written. So although legislating for a maximum charge cap would indeed remove the possibility for the pension saver (the person whose funds are being invested) to have the choice to invest in a wider range of funds, the bigger impact would be on members of existing schemes, who might lose either access to advice or else have reduced employer contributions so that advisers can be paid directly.
    So there are several strands to the imposition of a charge cap and several potential consequences. There is probably more merit in imposing a charge cap on new schemes, but I still believe that even if “default” funds were capped, there should still be the option for pension savers to choose to pay higher fees if they want access to specific funds, markets or sectors.
    And your supposition that people paying more money into lower charging funds leads to bigger pension pots is somewhat disingenuous. If the consequence of lower charges is to have indexed funds which are not monitored and where contributions are never reviewed (other than the impact of annual pay increased) then it really is rather unlikely that lower charges = higher pension funds. Financial advice actually is quite important, and people do not generally make their own decision to forego present wealth for future prosperity. You made the following excellent point: “Far more needs to be done to ensure employers, and pension providers, help consumers get the most appropriate product at retirement.” But you then asked the following rhetorical question: “But does this have to be at the expense of lower cost pensions during your working life?” I would say the answer is quite probably YES or at least MAYBE rather than your implied NO.
    The thing that will make the difference to pension pots is how much people pay in and also the level of risk they take in relation to their circumstances and markets. And you say it is no bad thing to choose passive funds. Well it can be a very bad thing indeed if the passive fund is tracking the wrong market or markets.
    If you remove the status quo where some existing schemes have higher AMCs (and which exceed the new maximum charge cap) to take account of advice costs then you take away the biggest influence on pension savers – a professional adviser helping them to make better informed, more relevant decisions about contribution levels and who can guide them on the right asset allocation choices.
    No doubt there are probably a fair few schemes where commission is paid to advisers who do not actually do anything for their money. But the solution is not to ban these schemes wholesale when the impact of such a decision would be to turn everyone to NEST in the absence of private provider capacity.
    The difficulty with the current playing field is that the employer has to make a decision about which scheme or schemes they will use to automatically enroll their employees. This means that they have to make a decision on behalf of each employee, and this is of course impossible to get right for all of the workforce. So surely the solution is to provide a default fund solution that DOES offer a low charge option, but where there remains the choice for employees to use a range of other funds which may cost more. These individual employees can then make their own assessment of the value of higher charges.
    And the biggest hypocrisy of all is that NEST would not meet the charge caps proposed in any case for a significant proportion of its members. The 1.8% initial charge on all contributions combined with the admitted very low annual management charge means that it is way above any of the mooted charge caps for many years.
    Tom McPhail has it right about the importance of making the right annuity decision at retirement, and financial advice generally helps people achieve the right outcome. But the key thing is to have a big enough cheque to spend on retirement income, and so it is just as useful to receive professional advice during the accumulation process.

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