Auto-enrolling employees into older-style pension schemes with high charges could lose up to 50% of their retirement income, according to research by the Pensions Institute at Cass Business School.
The research, Caveat venditor: the brave new world of auto-enrolment should be governed by the principle of seller not buyer beware, examined default funds in defined contribution (DC) pension schemes.
Academics at the Pensions Institute said an estimated 90-97% of employees will be auto-enrolled into default funds, and found that employees could be blindly enrolled into older schemes with charges up to six times higher than newer pension schemes. For example, the average annual management charge (AMC) for existing schemes is around 3%, whereas newer multi-employer pension schemes charge around 0.5%.
The research stated that this could be a particular problem for employees of smaller organisations because the administration involved in setting up a new pension scheme could lead many employers to use their existing schemes instead.
It also warned that advice on pension schemes for smaller employers is lacking because of the introduction of the retail distribution review (RDR), which will ban commission fees paid to advisers on schemes introduced after 1 January 2013.
Professor David Blake, director at the Pensions Institute, said: “Fortunately, there is time to address the problem of old high-charging funds, which for historic reasons are still widely used in the smaller employer markets.
“These employers are not required to introduce auto-enrolment immediately, but many organisations will need to be prepared by mid to late 2013.”
The research, which was sponsored by Now: Pensions, made several recommendations to tackle this issue, including the introduction of a kite-mark code for DC schemes to help employers choose schemes that offer good value, and that the principle of caveat venditor (let the seller beware) should apply to all schemes, as the buyer (the employee) is actually passively auto-enrolled into the scheme by the employer, rather than having a choice in which scheme is used.
The report makes some rather hyped-up claims regarding pension charges and seems to ignore the recent DWP research, which shows that average pension charges for workplace pensions are now below 1%. We believe the report overstates the risk of workers being auto-enrolled into very high-charging legacy pensions.
We are concerned that the Pensions Institute so readily dismisses investment performance and good member engagement as factors affecting pension payouts. It also fails to address the importance of employers providing their employees with an effective shopping-around process at the point of retirement.
The report also calls for a price cap on group pensions of 0.5%. We believe that this would stifle innovation, undermine member service and communication, and, ultimately, it would lead to poorer member outcomes.
There are some good suggestions in the report, for example, excessive exit charges on pensions are a problem and should be banned.
Charges are obviously important in terms of ensuring that members get the best outcomes at retirement, but we believe that cheap does not always equate to good, and that trustees and companies should be focusing on value for money, rather than solely the headline number.
We believe that monitoring the charges made to members on a regular basis is part of the good governance of DC schemes, and it is incumbent on trustees and companies to regularly challenge their providers on the fees they charge. This will be particularly the case as schemes grow in the light of auto-enrolment.
The report shows quite clearly that members are right to be concerned about the impact of high fees on their pension pots. The report also identifies the elements of a well-designed DC scheme, which looks very much like Nest. Low charges, a broadly diversified investment strategy, strong risk management and being run as a trust are all absolutely important to provide the kinds of outcomes that our members want for their later lives.
The report’s conclusion that long-term costs of high charging schemes, compared with new low cost schemes, are eroding half of your future retirement income is perhaps not such a surprise. We knew that some older schemes had very high charges, but the difficulties in getting to the bottom of the charges of the schemes currently on offer was a surprise. When industry bodies, like the Pensions Institute, have difficulty understanding the actual charges – finding that many of these are forgotten or not mentioned in the best cases and directly hidden in the worst cases – this is unacceptable. And it needs to change.
they are sadly meddling without understanding. Unless they are operating in a different world, we haven’t seen these mythical high charges for a decade or so. Secondly to put in place a cap when the FSA have unbundled the factory gate product from investment from advice is a challenge Houdini wouldn’t take on.
Finally given Steve Webb is advocating researching the defined ambition space, this may involve guarantees for some. How would and should this work.
All they have shown is that they have a spreadsheet.
Really disappointing stuff from a usually venerable institution
Perhaps a payment by results approach wouldn’t go amiss.
That might be the cause of a few grunts and buttock clenches amongst the overpaid and underworked pension managers ou there!
I am one of the authors of the Pensions Institute Report “Caveat Venditor”.
In response to some of the comments made:
1. We DID do our own extensive research on pension charges and it is beyond reasonable dispute that charges are opaque; it is also clear that some firms misrepresent their total charges. This charging issue is a scandal and badly needs further investigation.
2. We did “not so readily dismiss investment performance” as Tom McPhail asserts – indeed, we investigated this thoroughly – but I can assure everyone that charges are more important than investment performance in determining final pensions outcomes.
3. We called for a total charge rate of no more than 0.5% as reasonable good practice, not as a regulatory cap.
We welcome further feedback and/or discussion.
Message to the industry: get your act together.