With auto-enrolment firmly on everyone’s radar, the project begs some key questions that should be relevant for all retirement advisers. The main thrust of the debate has been over the balance between quality and cost, and the related issue of contribution rates, all of which are relevant for advisers involved in any form of pension planning.
When it comes to cost, the government is planning to draw a clear line in the sand. Pensions minister Steve Webb is consulting on bringing in a price cap. This cap is likely to be in the region of 1 per cent, which is much higher than the cost of some existing auto-enrolment pensions.
L&G’s auto-enrolment scheme comes with a total cost, including a multi-asset lifestyle default fund, of 0.5 per cent, which is equivalent in cost to most of the master trust providers, such as Now: Pensions, the People’s Pension and Nest. As a result the cap has come in for some criticism, with fears it may, counterproductively, increase the typical cost of an auto-enrolment pension. But plans with total costs of around 0.5 per cent – including admin and fund costs – look to be setting the benchmark for now.
With both the government and pensions industry focused on cost, it is inevitable that employers will be too. Given the scale of the challenge many employers, particularly small and medium-sized enterprises (SMEs), will be approaching auto-enrolment with a compliance, box-ticking mentality, seeking safety first. It is easy to see why they might think that safety equals low cost, and so the issue of quality is likely to be overlooked.
Quality and cost
So the question that auto-enrolment begs for any retirement planner is what is the benefit of quality over cost, and what does quality look like? Regular readers of this column will know that small annual percentage costs are every bit as damaging to an individual’s pension as the tabloid headlines would suggest. Low cost pensions are therefore certainly a benefit, and Mr Webb is right to focus on that issue.
But the biggest barrier to building up a decent pension is not cost or fund choice, it is contribution rates – the one element of a pension that any worker should be able to understand and take control of. Start saving a total of 12 to 16 per cent of salary early enough and anyone should build up a comfortable pot, almost irrespective of which scheme they are a member of.
The trouble is that most people do not realise this because standard communications – Statutory Money Purchase Illustrations (SMPIs) – are poor. Most basic defined-contribution (DC) pension schemes, which an auto-enrolment plan is likely to be, communicate annually with members following the SMPI guidelines. But that does not mean all communications are the same.
The goal of an annual statement should be to give the member a clear idea of what they are likely to receive in retirement income if they continue on their current trajectory. Observing some recent SMPIs, that crucial number – in real terms – can be difficult to see and can be confused by the mass of other numbers. To a layman, it is often unclear which projection is the one they should focus on.
For instance, in one SMPI issued by a large provider, a range of different projections were stated taking account of different investment return assumptions, but in these numbers no account was made for inflation. Further down the page was one rather lonely and much lower number which was a single real-terms projection. Out of all the numbers on the page this was the one that mattered, but it was easy to miss. Or rather, it was too easy to dismiss it in favour of the more attractive but less relevant numbers higher up the page.
Warning signs
Pension communications, irrespective of the type of scheme they come from, should act as warning shots to inadequate contribution rates. The solution to the predicament in this case was simple – increase contributions in line with inflation in order to achieve an outcome nearer to those being heralded in bright lights at the top of the page. But that conclusion could only be drawn by someone who understands how all this works and by studying the small print which explained the assumptions being made.
Clearly one solution is individual financial planning advice, which would be a benefit for most people. For clients receiving regular guidance in this way, the layout of their annual statements is less important as the adviser is there to interpret and analyse it for them.
In the majority of cases, however – particularly with auto-enrolment – there is unlikely to be direct advice. In this case IFAs can still make a real impact on this population by helping employers to select the pension provider that has the most effective communications system.
No auto-enrolment pension is going to offer sophisticated tailored communications packages; it is always going to be regimented and automated. But sophistication is not required – simple clarity of message is. If a company’s staff is really going to benefit from auto-enrolment, they must recognise as quickly as possible that they will have to save more. A simple, well-designed statement that explains the most likely outcome of their current contribution rate, in real terms based on a reasonable estimate of annuity pricing and what it might be if contributions were higher now, or escalating over time – and without any other distracting and unhelpful numbers – would be a massive boon to all concerned.
A statement should answer the following questions clearly and without distraction:
• What income am I likely to receive in real terms if I maintain my current plan?
• How much would this improve if contributions increase with inflation?
• How much would this improve if contributions as a percentage of current salary rose immediately?
And it should also explain clearly and simply how to make changes. This is not rocket science, but it is extraordinary how bad pension providers can be at communicating with their members.
Pensions, and investing, can seem very alien to many people. But just as with everything that seems complex, when broken down into the key components, anything can be explained in a way that an averagely educated 15-year-old can understand – as every IFA should know. We are not unravelling the mysteries of hedge funds, just trying to get the message across that saving a little bit more each month can make a massive difference in the long term.
Cost and quality
Cost does matter in pensions, but quality matters too. And quality should be determined by communication, not simply by fund choice, which in many ways is less important. An IFA who can help an employer address both these issues will be well worth any fee they charge.
