The new rules are in general good news for investors, writes Jeff Salway
Millions of people will pay lower charges on their workplace pensions after a cap on annual fees came into force this week, yet there may still be a price to pay.
Anyone automatically enrolled by their employer into a defined contribution pension scheme from 6 April will pay management charges of no more than 0.75 per cent a year if they are in a ‘default’ fund (into which the vast majority save).
The new rules also ban pension schemes from applying active member discounts, where active members pay lower charges than ‘deferred’ members on the basis that they’re still paying into the schemes. The shake-up, finalised by the government a year ago, passed almost unnoticed this week having taken effect on the same day as wide-ranging reforms giving people more control over their pensions.
Someone building up a pension worth £30,000 would save around £1,600 in a scheme charging 0.75 per cent, compared with one levying fees of 1.5 per cent, according to the Department of Work and Pensions.
Rachel Vahey, an Edinburgh-based independent pensions consultant, said: “The new cap is generally good news for pension investors. It should give those who are being automatically enrolled into pension schemes the confidence to know that charges are low, and that anything they save will be invested for their future.”
However the cap doesn’t go far enough, some critics argue. They point out that the figure excludes transaction costs, estimated at around 0.41 per cent and which compound significantly over the long term.
There are concerns that providers could introduce other charges that sit outside the cap, exacerbating a lack of transparency that makes it difficult for savers to know exactly how much they’re paying.
Some also believe it’s still too high. The Office of Fair Trading has put the average management charge on pension schemes launched over the past decade at just 0.51 per cent, whereas many older plans have annual charges up to 2.5 per cent. It has been suggested that schemes which previously kept their charges below the new cap may now increase them.
However for pension savers the most likely drawback of the new cap will be a restricted selection of funds in which to invest their contributions, reduced flexibility and more basic services. If the lower cap deters schemes from using investment funds charging, say, 1 per cent, that would rule out some of the best performing and most popular funds available to pension savers.
“Pension schemes and trustees will be conscious about keeping within the cap, and this will probably mean adjusting their investments choices to do this. For example, ruling out active investment management,” said Vahey.
“If pension savers want to explore different investment choices then they will have to look beyond the default, and probably be prepared to pay more.”
The new cap only applies to people who have been automatically enrolled into their employer’s pension scheme and pay into the default funds.
But some £2.65 billion is held in workplace pension schemes with annual charges above 1 per cent that aren’t covered by the new cap, according to the OFT. The cap may eventually be extended to the older pension plans that typically have the steepest charges, however.
Some of the UK’s biggest pension firms have committed to reducing charges on old legacy schemes containing assets worth about £10bn in order to bring them in line with the new cap, pensions minister Steve Webb claimed last month.
No further details are available as to when this might happen or which funds it would apply to, while the providers in question have not yet been identified. However the government said it would work with the Financial Conduct Authority and HM Revenue & Customs to identify any “inappropriate barriers” to improvements and which would need to be removed.
“The charge cap, at the moment, only applies to pension savers who are in a default fund, and won’t apply to older types of pension investment,” said Vahey. “But the government is working with the pension industry to try to bring down the costs of these older investments.”