Defined contribution pension schemes: Government plans to push consolidation of schemes

The authorities want to see far fewer pension schemes in operation, but do bigger schemes equal better returns for savers?

We have too many pension schemes operating in the UK, and by pushing them to wind up and pass their savers into bigger schemes, savers will be left better off in retirement.

That’s the view of the Government anyway, which has unveiled plans to push more schemes with up to £5 billion in assets under management to consolidate. 

Pensions minister Guy Opperman said that there was “no doubt in my mind” that there was the need for more consolidation within the market, arguing that it would lead to more savers being part of better-governed schemes, which enjoyed more investments in illiquid assets which could deliver better returns.

What’s more, while this current consultation focuses only on schemes with up to £5 billion in assets, this is only going to be the cut off level “for now” with bigger schemes also set to come under scrutiny in future.

So what does all this mean for savers like you and me?

Defining the contributions

First of all, it’s worth highlighting that we are talking about defined contribution pension schemes here.

This is where the amount that you are paying in ‒ your contribution ‒ is the bit that’s defined at the outset.

So for example, thanks to the workplace pension scheme, you’ll likely be paying in 5% of your own salary, with contributions from your bosses and the Government taking that up to 8% of your salary.

This is in contrast to defined benefit pensions, where the benefit ‒ what you get from the pension when you retire ‒ is known from the beginning.

These are the final salary schemes that used to be far more popular, where you built up the size of the pension you’d get from your employer based on your years of service and how that compared to your eventual salary.

For example, your job’s pension scheme might mean that you got 1/50th of your annual salary in retirement. If you spent 25 years in that job, then your pension would pay you half of your salary each year once you gave up work.

Too many schemes

According to the Government, since 2012 the number of different defined contribution schemes in operation across the UK has jumped significantly.

On the face of it, that’s a good thing.

The growth is down to the workplace pension scheme, which forces bosses to open pensions for their staff and contribute towards them.

It’s been an enormous success in encouraging people who might ordinarily have put off pension saving to start putting something aside for later life.

But the Government is concerned that having so many schemes operating is far from ideal.

Lots of smaller schemes have larger fees in place, with are delivering a mediocre performance.

The argument goes that by trimming the number of schemes, those that are left will be bigger and able to take advantage of far more forms of investment on the basis of the assets they have at their disposal, as well as enjoy higher standards of governance.

Going further and faster

Last year the Government announced plans to force pension schemes with up to £100 million under management to prove that they deliver good value to savers.

Those who were unable to do so would have to set out detailed plans for precisely how they would rectify that issue, or else have to wind the scheme up and consolidate with another scheme.

Those assessments won’t be introduced until the end of the year, but with the Government now looking for industry input on how it can encourage more consolidation among larger schemes, the message is pretty clear.

Those in charge of the nation’s pension saving want to see far fewer schemes in operation, and soon.

What’s more, if the initial measures to ‘nudge’ schemes towards consolidation aren’t effective, then the Government may look into ways to force those schemes to merge.

Does big = good?

While few would argue with the Government’s aim of delivering better value to the nation’s pension savers, it’s fair to say there have been some questions raised about its methods.

For example, Joe Dawbrowski, deputy director of policy at the Pension and Lifetime Savings Association, argued that it was quality, and not the size of the scheme, which really matters.

He added: “While costs and charges have a real impact on members’ funds, value for money in pensions needs to be seen in the round and should not be reduced to a discussion about cost alone.

"Well governed schemes are able to deliver value for money for their members regardless of pot size.”

That strikes me as a fair criticism. It’s true that having a lot of small, poorly governed schemes is not in savers’ interests, but pursuing mega-schemes may not be the answer either. 

There is a middle ground to be struck here, where smaller, creative schemes are not pushed out simply because of their size. Ultimately, so long as savers are benefitting from those schemes, the size shouldn’t be a deciding factor in their fate.