The Independent View: Want an extra £140,000 in your pension without paying a penny?

Pensions Road Sign 200This week brought welcome news for millions: Lib Dem minister Steve Webb wants to introduce a cap on pension fees.

Who cares? With 12 million people not saving enough for an adequate income in retirement, forcing charges to be capped could substantially improve the standard of living for pensioners without requiring an extra penny of their income.

The government is consulting on three different caps for workplace pensions: a 0.75 per cent cap, a 1 per cent cap, or a “comply or explain” cap, which would allow providers to charge between 0.75 and 1 per cent if they could justify doing so.

Bringing fees down from 1.5 per cent to 1 per cent might not sound like a huge saving. But over a working life, tiny charges become massive fees. Somebody who personally contributes £100 a month into a workplace pension across their working life could end up paying a whopping £236,000 worth of fees from their final pension pot – if their management charge is just 1.5 per cent. Bringing this down to 1% would save them over £60,000. Bring fees down to just 0.5 per cent would save each saver £144,200. And it’s doable – some are currently charging half a per cent in fees.

Think of the impact these charges are have on living standards. Losing money in fees during employment means people will see huge reductions in their retirement income. Even without the additional charges incurred when you turn your pensions savings pot into a monthly income through an annuity (which could wipe out a quarter of the value of the pension pot), the loss of £140,000 from their final pension pot at today’s prices works out at having around £600 less every month in retirement income from their pension.

In theory savers can shop around for the best deals but in practice it’s incredible tricky to unpick pensions jargon, and make calculations to work out what option is best. IPPR’s research shows that even those who have gone through auto-enrolment and attended work presentations, still don’t really understand how pensions work, what the risks are, and what they’re paying for.

And you can’t blame them:

  • Costs and charges aren’t transparent: even the Office of Fair Trading had problems getting working out the charges levied on different pensions.
  • …and they’re numerous: the OFT also found there were 18 different types of charges savers might be paying on a single pensions ‘pot’.
  • The vast majority of pensions have no guarantees on final pot size or pension income, with the demise of final salary or ‘defined benefit’ pensions.
  • Retirement income is uncertain, and depends on how well investments have performed, charges made by the providers across their working life, charges made by the company offering the annuity at retirement, average life expectancy and Bank of England rates
  • What retirement income actually means for living standards depends on inflation. Savings to allow for what sounds like a decent salary now, maybe be worth substantially less.

Given just how complex pensions are, it’s not reasonable to expect cost and quality to be driven by consumer choice. Having a cap is a good first step to ensuring savers are getting a good deal. But the government will need to ensure the cap covers all fees levied – not just the annual management charge. And the cap should be ambitious – in the Netherlands the average charge on their collective pensions is just 0.15 per cent. Achieving this would need a much more radical shake up of pension schemes, including substantially reducing their number and increasing their scale. It would also probably require a wider adoption of passive investment strategies.

* Imogen Parker is a researcher at Institute for Public Policy Research

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20 Comments

  • Eddie Sammon 1st Nov '13 - 12:43pm

    Thanks for the article. Although I’m not naturally a price capper, I think a 1% cap with no questions asked could work. I also think it is unfair to use this figure of £140-170,000 because we are talking about this amount of money in 46 years’ time.

  • Steve Webb is my new hero.

    This post illustrates some really important points. Firstly, the vast scale of the profiteering (rent extraction in formal terms) that’s going on in the City at the expense of the real economy. The Dutch experience proves it doesn’t have to be like this. The implication is that the immense profits of the City are not necessarily, as its boosters like to claim, evidence of it being the crown jewel in the UK economy so much as a tumour that is gradually killing its host. The real economy will recover only when it’s reined in.

    Secondly, the impact of even small changes in compound interest rates over long periods. (Management fees are effectively a negative interest rate). This lesson applies across the public sector and is a big reason PFI schemes are a really, really bad idea.

    Thirdly, a political economy point. The best way (probably the only way in the long term) to achieve social justice ends is to structure markets so that they deliver the desired outcomes by design – and that means in part regulating what participants are/are not allowed to do. Capitalists understand perfectly well that markets deliver what they are programmed to deliver and, absent any political input to the contrary, will structure them to suit their own ends which usually comes down to rent extraction – cue the cost of living crisis. That is why following privatisation of the electricity industry in the early 1990s it was promptly reorganised by the City leading eventually to the vertically-integrated oligopoly we see now. Labour’s idea of letting ‘the market’ decide then taxing energy company profits, bank bonuses etc. after the event is shutting the stable door after the horse has fled and the economic damage done.

  • Paul in Twickenham 1st Nov '13 - 1:24pm

    @GF – spot on.Let me give a simple example in the form of stock loan for short-selling:

    For those not familiar with this nonsense, here’s how it works: your pension fund management company is approached by a hedge fund (basically a bookie gambling on his own account) who says “can I borrow 10,000 of the shares you hold in the Acme Widget Company? I’ll pay for a fee for borrowing them and I’ll give you them back in a month’s time”.

    The pension fund agrees to this deal and the hedgie goes off and sells the stock he’s just borrowed. He does this because he hopes and expects that the share price in Acme is going to fall and so he will be able to buy the stock back for less than the price at which he sold it and so he will make a tidy profit, even after paying the pension fund manager his fee. And the pension fund manager says “well I don’t mind loaning out the shares, because I’m holding that stock for the long-term, and short-term price fluctuations are an irrelevance to me but the fee from the hedgie is very useful”.

    Now this is clearly nonsense: like some strange version of the first law of thermodynamics, wealth has neither been created nor destroyed, it has simply come to rest in the wallet of the hedge fund manager.

    There is a large and thriving industry that is based on taking wealth that has been created by the productive work of millions, making vague and meaningless promises of “jam tomorrow” to the pension holders, and giving huge immediate wealth to a tiny self-selecting elite,

  • “And the cap should be ambitious – in the Netherlands the average charge on their collective pensions is just 0.15 per cent.”

    Agree it should be ambitious and a stretch for providers – I suggest given the Netherlands experience a 0.75 per cent cap isn’t ambitious enough…

  • Eddie Sammon 1st Nov '13 - 4:07pm

    Guys, we need to not automatically assume that all pension providers are ripping people off through hidden fees in the City. Would any of you guys set up and administer a £10,000 pension for £50 quid per year (0.5%)? Probably not. If hidden charges are the problem then hidden charges need to be dealt with – not an overly aggressive cap in the prejudice that they are probably secretly earning more money hidden somewhere anyway. There are many small pension providers that have nothing to do with the City and we need to encourage more of them.

  • Eddie Sammon 1st Nov '13 - 4:30pm

    You’ve got to look at the costs of running a financial services business too – a 0.5% charge on small pensions doesn’t even covers costs. Let’s tackle the people ripping others off and not showing customers the effect of their fees (which they have to do anyway), but we shouldn’t be choking off the SME and small consumer market with excessive regulation.

  • Eddie Sammon 1st Nov '13 - 5:31pm

    I know my example wasn’t perfect, but we still shouldn’t be an anti-business party. As I am sure you will agree Simon.

  • @eddie
    Agree we do need to be careful to ensure charges are not ‘hidden’, but we need to understand what the Netherland’s are doing to achieve their average level of charges.

    Also we shouldn’t forget that current savings rates are in the range 1.5~2.0% AER, so charges do have the potential to consume a significant proportion of a typical fund’s growth.

  • Eddie Sammon 1st Nov '13 - 11:08pm

    Roland, I’m happy with anyone who wants to compare what other countries are doing to achieve low charges.

    On your other point I would say that even though interest rates are low, equities have still been performing well and should continue to do so over the long-term. Low interest rates usually lead to high equity and bond prices, so the risk-premium should remain over the long-term – as long as markets are fairly healthy.

  • @ Eddie Sammon – “we still shouldn’t be an anti-business party”

    This sentiment, expressed in various ways, has become such a commonplace that we hardly notice it anymore but subject it to any analysis and it turns to dust. One of the most successful and profitable businesses in the world is drugs dealing yet I have no hesitation in being “anti-business” in that case and many others besides. Some of the businesses I most dislike involve people in nice suits who pose as (and are generally regarded as) pillars of the establishment. Our views on any particular business MUST be informed by judgements based on morality and ethics whether we realise it or not.

    If part of the car industry (in the days when some of it was still British owned) was somehow getting away with charging far over the odds (on a roughly like for like basis) compared with foreign competitors would we celebrate that or would we conclude it was heading for a collapse? It may well be that Steve Webb’s proposals will save the City from a mass defection to Dutch pension providers much as eventually, inevitably, happened to the British-owned car industry. Similarly, many consider that FDR’s 1930s reforms saved capitalism in the US from its own excesses.

  • Eddie Sammon 2nd Nov '13 - 6:39pm

    GF, I don’t think we need to be introducing a cap because some people think they are incapable of setting a competitive price on their own. Besides, you don’t get tax relief on a Dutch pension if you are UK resident so it’s not even the same market.

    I don’t believe in the Labour approach of “banning things we don’t like and controlling things we do”. Yes they have never said it like that, but that is what their policy seems and what you refer to by mentioning drug dealers, businesses you don’t like run by men in nice suits, saving the pensions industry from itself and suggesting the government can run car businesses better than the manufacturers.

    I’m not someone who thinks “public bad, private good” as can be seen from wanting nuclear energy to be publicly funded and owned and the same with public services.

  • @eddie re: cap

    I suspect that what is needed is a ‘half-way’ solution, a bit like East Coast Mainline Ltd: We need a state/community owned operator who can set a competitive market rate (ie. more than cover their operating costs), and is the default provider when people don’t make a decision, but people are free to use the market…

    Interestingly, with the state effectively owning a few banks, this wouldn’t be too difficult to set up, before 2015…

  • Eddie Sammon 3rd Nov '13 - 4:29pm

    Roland, I’d be fine with a half-way house solution and even a state owned provider in the market place, as long as it was a level playing field and the state owned operator didn’t receive a constant stream of handouts.

    Funnily enough, I’m indifferent about re-privatising the banks or keeping them public, I just don’t want the government to sound desperate to sell and receive a rubbish price like Royal Mail. We don’t have to sell our shares.

    Anyway, it will take more than good policies to win me back as a voter because of Steve Webb’s and other people’s dodgy figures. I hope he is happy about his full frontal attack on the industry, smearing and disregarding inflation in long-term projections.

  • Eddie Sammon 3rd Nov '13 - 4:33pm

    In fact I’d also object to a default provider of any kind, which I think it kind of what we have with NEST, because that is effectively a constant stream of handouts and means they don’t need a marketing budget.

  • Eddie Sammon 3rd Nov '13 - 4:49pm

    By the way, disregarding inflation wouldn’t be so bad if he hadn’t used 7% investment growth rates. You can’t use maximum figures when it suits you and minimum ones when it doesn’t. 7% growth used to be a standard industry assumption and it always included 2.5% inflation. Steve Webb should apologise for leaving the latter part out of the equation.

  • >7% growth used to be a standard industry assumption and it always included 2.5% inflation.

    I thought that was part of the problem with the final salary pension funds (in addition to changes in taxation), in that many funds were not achieving this benchmark. Certainly the use of government approved industry benchmarks was part of the Endowment mis-selling…

  • Eddie Sammon 3rd Nov '13 - 9:37pm

    I’m not sure Roland. I’m a bit rusty at the moment, but I don’t think the government should interfere with growth rates. I never accept commission so I don’t earn more money if I use higher projections, but I think the freedom to set my own is an important one. It doesn’t feel fair when the few ruin it for the many. As I am moving back towards industry I am moving towards libertarianism again, sigh!

  • Eddie Sammon 4th Nov '13 - 12:05am

    After another wave of volatility from myself I’ll say that moderate levels of regulation can be fine and is actually currently forcing a lot of positive change in the financial services industry, but they haven’t got everything right. I think the Liberal Democrats have to do their best to reassure everybody that they aren’t going to take people’s livelihood away from them, either through excessive regulation and cheap subsidised competition, or through excessive Tory cuts on jobs and welfare.

    Regards

  • Matthew Huntbach 5th Nov '13 - 2:37pm


    Given just how complex pensions are, it’s not reasonable to expect cost and quality to be driven by consumer choice.

    In other words, free market theory does not work, or at least the more it gets away from concrete objects on real market stalls, the less it works.

    Fairly obvious, yes, so why is the “competition drives up quality” message still so often lazily put out as a slogan, and is still the centre piece of this government’s strategy – often with the explicit support of Liberal Democrats, particularly those the party’s leader has chosen to join him in government office?

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