Trust must be restored to our pensions system

Published by Jeff Prestridge on 18 September 2012.
Last updated on 19 September 2012


We are about to undergo a pensions revolution in this country, a revolution that hopefully will trigger a renaissance in the long-term savings habit.

Beginning this October, workers will start to be automatically enrolled into a pension scheme by their employer. It's a process that will impact on all British businesses - big firms first, small firms last - and few workers will be excluded.

For the first time in their lives, some 10 million workers - part-timers, the lower paid - will begin to build a stake in a low-cost pension that ultimately will provide them with an income in retirement to supplement their state pension. It's empowering and it's welcome.

Yet, the imminent arrival of this new world of pension autoenrolment, with its emphasis on value for money, is also putting the spotlight on the existing pensions regime that now sees a majority of workers build retirement funds through a so-called defined contribution scheme.

The current pension system

These plans deliver a pension based primarily on the performance of the underlying fund assets. They are more risky than traditional defined benefit pension schemes where the final pension delivered is determined by the number of years worked and a worker's final salary at retirement.

These latter schemes, alas, are now primarily the preserve of public sector workers - they are too expensive for most British businesses to maintain.

Recently, a mix of politicians, worker representatives and pension commentators have begun to question whether the pensions industry can continue to justify the charges it heaps on investors in defined contribution plans, especially in an era of uncertain stockmarkets, economic stress and low annuity rates. Pension investors, they say, deserve a better deal.

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The next big scandal

Ed Miliband, Labour leader, got the debate started when he referred to pensions charges as the next big scandal to affect financial services. Not only are charges too high, he said, but many pension fees remain undisclosed. He called for fees to be capped and for all charges to be disclosed so that investors could compare charges across providers with confidence.

Meanwhile, pensions minister Steve Webb accused pension companies of "tearing the heart out of people's pensions". Yet the most thought provoking work on pension fund charges is that published by the Royal Society for Arts (RSA). It calls for managers of company pension funds to provide more meaningful and regular information about the charges that diminish pension pots.

The RSA says pension providers get away with murder because they couch all their charges in percentage terms, which is hugely misleading. A 1.5% annual management charge (AMC) may seem reasonable but when its impact on returns is expressed in pounds and pence it is debilitating.

For example, a 25-year-old saving £1,000 a year in a pension scheme for 40 years without charges would see that sum grow to £248,170, assuming an annual return of 6% and premiums increasing by 3% a year in line with inflation.

This fund would in turn buy an annual inflation-linked income of £16,080. But if the fund were subject to an AMC, the RSA says the income would be reduced to £9,900 - so someone who paid no fees would get a 60% higher pension than someone who pays 1.5% a year.

The RSA concludes that pension savers should be given annual statements that show how their scheme is doing – with everything expressed in pounds and pence.

Such transparency, it says, would bring pressure on fund managers to offer more competitive charges as empowered investors question the value they are getting. And the RSA is spot on. The public deserves nothing else. If we are going to be encouraged to take up the savings habit, then we must be able to trust those who manage our money to give us a fair deal.

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