By Dale Critchley, Policy Manager, Aviva
On the face of it this is great news for members, but there are downsides to the almost relentless focus on cost. A race to the bottom has been happening, with advisers and employers squeezing providers for every 0.01% discount they can get. Low margins mean it’s a difficult market for new operators to break into, as evidenced by the number of master trusts electing to call it a day.
Even where provider charges are very low there’s still a focus on low priced passive funds. Few schemes are seizing the opportunity to increase the charge paid by members to cover more expensive investments that could generate higher returns.
The focus on charges isn’t going away. Defined contribution occupational pension schemes will have published their charges online by early November, with the FCA set to make equivalent rules later this year for contract-based pensions. It won’t be long until we see someone publish a league table with the ‘winner’ being the scheme with the lowest charge.
But charges aren’t the sole indicator of value. Scheme design, member decision making and a robust default fund providing solid returns can have a more significant impact on an individual’s pension pot and their quality of life in retirement.
Let’s look at a practical example (the full list of assumptions is below*):
Jane is 22 years old and joined her workplace pensions scheme in April 2019. Her salary is £25,000 and contributions to her workplace pension are 8% of qualifying earnings. These continue for 46 years, until she retires at 68. Let’s ignore questions of whether this saving level is adequate and just look at some numbers.
Scenario 1
- Jane pays an annual management charge (AMC) of 0.75%
- At retirement she would have a pension pot worth £105,909
Scenario 2
- Jane pays an AMC of half that in scenario 1, 0.38%
- At retirement she would have a pension pot worth £116,741
Clearly, charges make a difference – and I would never suggest they be overlooked. By decreasing Jane’s AMC by around 50%, her pension pot has grown by around 10%.
But let’s look at it from another angle:
Scenario 3
- Jane pays an annual management charge (AMC) of 0.75%
- Jane and her employer decide to increase her contributions from 8% to 12%
- At retirement she would have a pension pot worth £158,864
Scenario 4
- Jane pays an 8% contribution and an annual management charge (AMC) of 0.75%
- But the default fund grows by an additional 1% per annum
- At retirement she would have a pension pot worth £137,491
I’m keeping the maths basic for the sake of this example, but the simplest way to improve income in retirement is to pay more in. An increase in contributions of 50% increases Jane’s pension pot by 50%.
But employers, trustees and individuals shouldn’t lose sight of the impact of investment returns. Increasing returns by 1% increases Jane’s fund by nearly 30%.
A focus on charges is important, but with charges so low there’s often little room for further reductions. Improved employer and employee engagement manifested in increased contributions and greater focus on default fund returns, not just charges, could help millions of people like Jane have a more prosperous retirement.
*Footnote
• Member joins the workplace pension scheme in April 2019 aged 22
• Contributes for 46 years (Mar 2065) to retire at 68
• Earns £25k salary
• 8% contributions
• Qualifying earnings
• 2.5% returns
• Calculations adjusted for inflation
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