Research carried out by the Institute for Fiscal Studies (IFS) and funded by the Economic Research Council, found that people with older defined contribution (DC) pension schemes are at risk of losing thousands of pounds due to high charges and often these were not justified by better performance.
The data showed a gradual decline in fees over past 20 years and so people in their 50s were generally the worst impacted by the higher costs being paid. The IFS concluded that very few pensions taken out 20 years ago or more had low charges. The average fee for deferred pensions taken out in the 1990s was above 1.1% of fund value which is considerably higher than the current DC charge cap of 0.75% per annum.
What is the charge cap?
The charge cap is a government-set limit and is the annual amount that can be charged to savers in default arrangements within DC pension schemes used for auto-enrolment. Default arrangements are the investment fund or funds that an employer or scheme trustee have chosen for members who haven’t actively made any investment choices.
The cap has applied since April 2015 and is currently set at 0.75% per annum of funds under management within the default arrangement. The cap applies to all scheme administration and investment charges, excluding transaction costs. This means it doesn’t currently include costs that are incurred by the investment manager when assets are bought, sold or lent by the fund.
It is important to keep in mind that this is the charge ‘cap’ and so many modern schemes will have an offering which is considerably lower than this – particularly where passive funds are used which is common within default DC arrangements. For those that aren’t aware, a passive fund is an investment vehicle that tracks a market index or segment. For this reason, they are normally considerably cheaper than managed funds which require the fund manager to spend time researching and analysing opportunities to invest in. Certainly, paying 0.75% per annum for a passive portfolio is something we would consider very expensive still.
The IFS warned that leaving such high charge pensions where they are meant savers would very likely be missing out on higher returns. For larger pots the difference between higher and lower charges could literally be measured in the tens of thousands by the time they come to retire.
Watch the risk profile
The research also found that older deferred pensions may not be invested in line with the correct risk profile. The consequences of this may be more precarious for people approaching retirement as they may find that they are invested in a much more volatile portfolio than they would otherwise be comfortable with; or even deemed suitable, based on their capacity for loss and retirement income needs. Good financial planning should ideally see clients revisit their risk profile on an annual basis when approaching retirement. For those further away less frequent reviews may be adequate, but still important not to neglect for years on end.
Would you benefit from a review?
This research certainly rings true from our own experiences of analysing significant numbers of client pensions. Generally speaking, the longer a client has held a pension – or investment for that matter – the more likely we can help them make cost and performance improvements by moving to a newer offering.
Whilst reducing cost is one metric that can be easily compared, there are also potentially other key benefits that accessing a more modern scheme might provide. These will include the range of investment choices available and also what options are accessible to the member at retirement. In addition to being more expensive, many older schemes also have poorer investment outcomes and a lack of flexibility when it comes to retirement options; for example, the choices at retirement may be limited to either an annuity purchase or full encashment. Given the vast majority of clients are making use of flexible drawdown nowadays (the ability to choose how much you withdraw and when), a transfer may ultimately be required anyway.
Navigating the pension landscape can be a confusing journey, particularly for the untrained eye. Getting professional advice can often really add value here as we can provide you with objective analysis and feedback as to how your plan compares to the market as a whole and the area or areas where you could enjoy improvements. If you would like to learn how we can help, please contact us and we will be in touch right away.