The BBC reports on Steve Webb’s planned “full frontal assault” on the charges that pensions companies levy for management of pensions funds:
Pensions minister Steve Webb told BBC Radio 5 Live Breakfast that the move was just the start of a much broader review into pensions charges.
He said: “We do have powers to cap a much wider range of charges. The document today looks at banning something called active member discounts. That means when you leave a firm they jack your charges up – we don’t think this is right so we will probably ban those.”
Steve has written an article for the Telegraph in which he outlines the rationale behind a cap on pension charges. He begins with a provocative comparison of pensions companies with the unscrupulous and amoral Thenardiers from Les Miserables:
In the musical Les Miserables the inn-keeper sings a memorable song about the ever more inventive ways he has found to fleece his customers: “Charge ‘em for the lice, extra for the mice, two per cent for looking in the mirror twice”.
But it is not just dubious inn-keepers who have been finding ever more inventive ways to extract money from their clients.
The pensions industry also has ‘form’ in this area, with a recent report by the Office of Fair Trading identifying no fewer than 18 different sorts of charges which can be taken from people’s pensions.
He outlines how a seemingly small administration charge can mount up over the years:
Even at this charging level, we have calculated that someone saving £100 per month through their working life could see the huge sum of £160,000 removed from the total value of their pension fund by charges.
When people are saving so little for their retirement, we cannot go on letting schemes charge what they like, especially when millions of people are being automatically enrolled into workplace pensions over the coming years.
The consultation will have 3 parts:
Our paper looks at a range of options, including an outright ban on all charges above 0.75% per year. Another option would be to allow slightly higher charges, but only where the provider can demonstrate that the extra cost is bringing value-for-money to the scheme member.
We must also make it easier for people to see the charges on their pension and know what that means for the size of their pension when they retire.
As well as our proposals for a cap on pension charges, we will consult on banning the practice of ‘deferred member charges’ where an employee’s pension scheme charge is quietly increased when he or she moves employer.
And if you were wondering why the words stronger economy or fairer society hadn’t yet appeared, worry not:
We want to build a fairer society, and as part of that, my job is to make sure people get better pensions. So when people put hard-earned cash into a pension I am determined to make sure it doesn’t get gobbled up by excessive charges. I’m confident that our proposals will make the system fairer for anyone being automatically enrolled into a workplace pension and will finally address the issue of charges which has been neglected for far too long.
You can read the whole article here.
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19 Comments
I can’t see the maths here (the BBC using the same figures said that people could lose up to £250,000). I have been paying in £100 a month for 30 years. That means I have paid in £36,000. The fund managers have invested that money and grown the lump sum to about £100,000. I can’t do the compound interest calculations, but intuitively it seems impossible that they could have extracted more than a few thousand pounds in management fees, and £160,000 seems completely impossible.
@Tony Hill. If you pay in £100 per month for 30 years then a pension calculator will advise you that you will end up with a pot of £120, 000-ish. This is based on a presumed compounding interest rate of 7% which is the ludicrously high return that pensions companies typically apply for their “representative” projection of final value. You have actually got a compound rate of 6% which is jolly good although if you are highly exposed to equities then you’re riding the QE wave of stock market growth right now.
Hopefully this includes a ban on churning and trading fees which are the off-balance sheet dirty little secret of the pensions industry. But in general this is a very good thing and Dr Webb is to be congratulated.
I shoukd add that the £160k charge effect is easily calculated. If you put £100 away for 50 years at a compubd interest rate of 7% then the final value is £550k. At a compound interest rate of 6% the final value is £380k. It’s no wonder that Albert Einstein deckared compound interest to be “the most powerful force in the universe”.
Paul, churning and trading fees as far as I can see are still to be addressed. The recent OFT report (pdf here: http://www.oft.gov.uk/shared_oft/market-studies/oft1505) is well worth reading on a number of points but is lukewarm on the issue. But in particular trading charges are the one big exception in the demands for the reporting of management charges.
I would favour us as a party taking a clear stance that long term investment in equities with strong fundamentals is in the interests of pension savers, and that high churn strategies and exotic assets generally are not, and so there is still much work to do in correcting incentives in the industry. (Though I wouldn’t go so far as to try to ban churn and exotic assets)
It wouldn’t be fair to cap charges at 0.75%. If someone has £10,000 in their pension fund it is only £75 per year, which wouldn’t even cover the admin cost. If a pension has £75 taken from it then once growth at 7% has been deducted it would cost the pension 0.80625%, or £80.63.
It is not fair to add the lost interest to the providers fee – if you buy an expensive car you lose interest because you could have put the money into the bank instead, but we don’t advertise that next to car prices.
A 0.75% cap would mean the only people getting pensions would be people with big pots and do we really want a world where only cheap pensions are available on the market? Cheap isn’t always better.
It is also strange considering on the one hand we are slamming Ed Miliband for his price controls and then introducing them ourselves elsewhere.
Pensions are not a monopoly – there are plenty of providers and also alternatives that they have to compete with such as normal investment funds, businesses and direct property.
I am not in the pensions industry but the government is getting close to my industry with this and I don’t think I should be asking for fee caps for other people unless I want them on myself. This certainly tests my centrist credentials and gives me something to think about.
Eddie Salmon – in your example you have £10k as a lump sum invested with a fund manager. He gets a compounding return of 7% on your money and every year he takes a management fee of 0.75%. What is the total cost if you hold the investment for 30 years?
At 7% (the return without fees) the £10k grows to £81000.
At 6.25% (after taking his small fee) the £10k grows to £65000.
That is a difference of £16000 (or a loss of 20%) in the amount you get because of that small 0.75% annual fee. But the real issue is that it dies not end there. The pension funds have a bunch of clever wheezes (such as pointless trading to incur transaction costs) that can result in even bigger reductions to your final pension than the headline fees.
Paul, £10,000 * (1.07) ^ 30 = £76,123 – not £81,000.
I’ve just done the exact same calculation as Steve using my own spreadsheet, my own calculator and then an online calculator and I get the same answer all three times, which is a £144,972 difference – not nearly £170,000.
I’ve also tested my calculator with pension providers in the past, so it seems Steve’s department is using a different formula to all us. Once you deduct inflation from this at 2.5% the real difference reduces to £46,557.
I did £1200 per year growing for 46 years with contributions growing at 4% per year and interest at 7% per year.
Step 1) Open a book and learn some of the basics about diversification of investments, just so you don’t put all your eggs in one basket when you do
Step 2) Open a SIPP, once every six months log in and put some of your money somewhere. Market prices are reflective of the view of the investment community so you will trade more or less as well as them, but without paying the fees, so you should come out ahead in the long run.
People who are too lazy to do steps 1) and 2) are essentially buying a money-sitting service at a price they have agreed to pay.
Eddie. I think the difference is that I am calculating interest at one twelfth of 7% per month which gives a compounded simple rate of 7.22%. If you feed 7.22% into your annual spreadsheet then I think the numbers will balance. My 6.25% example uses the same methodology. But the key point remains the same: a small change in fees results in a large net effect on the return expected on managed capital.
Yes Paul, I get the same figure if I use 7.22% as the AER.
The government have got their figures wrong because what they have done they haven’t done correctly and secondly they have left off a massive part of the calculation, the discounting for inflation at the end of it.
By the way I agree with the key point you make about the difference that compound charges make, I’m just annoyed that they government have massively inflated the figures.
I made a mistake in my first post by compounding a 0.75% charge to a 0.80625% charge, but the rest of my calculations are right. If fees are flat then you have to convert them into percentages of growth lost, but if the fees are already percentages then you don’t have to.
A key point about pension investing is that for most people it is a waste of money. Although they get tax relief on contributions, they will be taxed on the amount they take out of the pension except for a tax-free cash sum of 25% of the fund. I suspect that the 25% TFCS will not last forever. It will just prove too tempting for future governments to leave that amount of money untaxed. In addition, there are restrictions on when the money can be taken and how it can be taken. A person made redundant at 45 with a mortgage and family to feed would be far better off with his/her pension contributions money in his/her current account rather than invested in a pension until he/she is 55. Those are just some of the reasons why basic rate taxpayers might be best advised to invest in other vehicles than pension funds. It’s a reason why I think auto-enrolment is a bad policy that will eventually turn out to be another problem (like the pension review of the 1990’s) that has to be unravelled.
As a recent short series in the Money Box slot on Radio 4 explained, the financial consumer is paying for the City is myriad ways, including 16 different ways to take money out of your ISA. Some of the ways the City makes money out of our pensions are amazing, such as trades which anticipate a trade by the pension fund manager by a millisecond, and custodians lending stock overnight and pocketing the fee for it, David Pitt Watson, who analysed pensions in the UK and Holland, concluded that after contributing to a pension over a working life time a Dutch pensioner will be 50% BETTER OFF THAT HIS UK COUNTERPART because of the charges, fees, commissions and margins which are creamed off by the institutions here. Which? and the Consumers Association, though claiming to be a consumer champion, have failed dismally to grasp this nettle and have not started serious campaigning on this. The press won’t, because it relies on financial advertising, so it is gratifying that Steve Webb is hoping to do something about it. What really has to be done is to dismantle the City structures which allow these practices to continue while pension trustees and pensioners remain ignorant of their effect and seemingly powerless to stop them.
So within a month of accusing Ed Miliband of communist-style state intervention for wanting to cap energy prices, the government has happily capped rail fares and now pension charges.
@Stuart Mitchell
“So within a month of accusing Ed Miliband of communist-style state intervention for wanting to cap energy prices”
I’m not sure anyone in government has used those words, but if by “communist-style state intervention” you mean grossly incompetent and deceitful, then you are pretty much spot on.
BTW, if you check back, you will find that governments of all parties have always capped rail fares and many charges applied by the financial services industry.
Hmm, I’ve just made my calculator more accurate and I get £155K, which maybe the DWP rounded up to £160K (the figure reported in the Telegraph), and somehow this figure has grown to £170K in the BBC and on the infograph. Steve mentions this doesn’t include inflation, but why doesn’t it? Because inflation reduces this figure to around £51K.
The average charge for pensions set up in 2012 is 0.51% per annum, so they are hardly a bunch of robbers. Politics is meant to be enjoyable, but how can it be when people are producing misleading figures and using them to attack people.
@Simon
“I’m not sure anyone in government has used those words”
I think you’ll find that Cameron and Osborne both described Miliband’s plan as Marxist, while Ed Davey on this very site called it a return to “the bad old days of state intervention”.
“BTW, if you check back, you will find that governments of all parties have always capped rail fares and many charges applied by the financial services industry.”
Er, wasn’t that what I said in my previous post Simon? That the government is happy to interfere with markets when it suits, but throws words like “Marxist” around when somebody suggests doing the same for the obviously dysfunctional energy market. I’m glad you’ve noticed this too.
The fact is, if the markets actually worked, we wouldn’t need an energy secretary at all.
It has always seemed strange to me that pension charges are levied as a percentage of the total value of your fund. Would it not be fairer. and also incentivise the fund manager to maximise the growth of the fund, for the pension charges to be based on a larger percentage of the annual growth in fund value? This would mean that if the fund fell in value during one year the fund manager would not generate any fee at all.