On 16 November pensions minister Guy Opperman announced the outcome of the government review of the charge cap that applies to member-borne levies in default investment funds within defined contribution (DC) pension schemes.
Perhaps surprisingly, at least to some, the government decided not to reduce the level of the charge cap, or to increase the scope of the cap to include more types of costs, such as transaction fees.
Whether or not the cap should change has become an increasingly polarised debate. On one side of the argument there is concern about the impact of the disclosed charges on the value of members’ pensions, and the potentially larger impact of undisclosed charges. On the other side there is concern that a more restrictive cap could affect the range of investments open to be used, again leading to worse outcomes for members. So who is right?
Before considering that thorny question, it is worth reminding ourselves of what the charge cap is for and what it covers, as well as examining the marketplace into which it has been introduced.
The charge cap, equivalent to an annual management charge of 0.75 per cent a year, was introduced in April 2015. The cap applies to all scheme and investment administration fees, excluding transaction costs and a small number of other specified costs and charges.
The rationale behind the charge cap is to ensure that members’ funds are not eroded by excessive charges, as part of series of measures designed to increase minimum standards and improve the governance of the default funds used within automatic-enrolment pension schemes. The level of charge can have a significant impact on final outcomes for members.
All things being equal, a 0.1 per cent reduction in charges could increase the value of the final pension for a typical median-earning woman (including some career breaks) by around 2.5 per cent.
- Last month, the government decided not to reduce the level of the charge cap on default DC funds.
- The charge cap is to ensure that members' funds are not eroded by excessive charges.
- The charge cap only covers some, not all, costs.
It is also worth remembering that the charge cap applies only to the default investment funds offered within auto-enrolment. So there are plenty of other investment funds offered to members of schemes in which they have been automatically enrolled that can have charges higher than the cap.
However, in reality the vast majority of people who have been automatically enrolled are in the default fund. In master trusts, more than 99 per cent of automatically enrolled members remain in the default fund, as do 94 per cent of group personal DC arrangements. Therefore, most individuals’ investments are covered by the charge cap.
It is also the case that in master trusts, in particular, the charge levels faced by members are already significantly lower than the 0.75 per cent cap. The Pensions and Lifetime Savings Association reports the average charge of the DC schemes in its membership as 0.4 per cent.
The announcement does suggest that small schemes might be more at risk of facing higher charges, and references the recent proposals to make consolidation of small schemes easier. But in reality, the vast majority of those automatically enrolled are already facing charges below the cap. So do we need it?