Proposed change would allow pension funds to invest in assets promising higher returns.
The Government’s auto enrolment scheme has been an enormous success.
Compelling employers to set up workplace pensions for their staff ‒ and then contribute towards those pensions ‒ has meant that far more people are now preparing financially for their later years than would have been the case otherwise.
The latest data from the Office for National Statistics shows that around 88% of eligible employees ‒ which equates to a whopping 19.4 million workers ‒ were participating in a workplace pension in 2020.
That level of engagement is all the more promising given the way that minimum contributions have increased over the last couple of years.
However, proposed changes to the rules governing how these schemes can invest were announced this week, with the idea of opening up a more diverse range of assets that these can invest in, but with the potential of incurring higher fees along the way.
Limiting charges ‒ and options
The suggested change covers the pension charge cap.
The pension charge cap only applies to workplace pensions ‒ those set up through the auto-enrolment scheme ‒ with the idea of ensuring that savers do not end up paying through the nose for the returns they get.
The charge cap covers the annual amount savers in default arrangements ‒ those funds that an employee or scheme trustee opts for on behalf of savers who haven’t actively chosen a fund for themselves ‒ and is currently set at 0.75% of the funds under management.
However, by its very nature it does serve to limit the assets that the pension scheme can invest in.
Riskier, illiquid assets may have the potential to deliver great returns ‒ as well as disastrous losses ‒ but they tend to come with meatier, performance-based fees.
In other words, the better the asset does, the higher the charges you end up having to pay.
As a result, many of these investments were effectively off-limit to workplace pension schemes, since there was no real way to make them work within the charge cap.
Changing the goalposts
The Department for Work and Pensions (DWP) wants to change that though, by essentially exempting these illiquid assets from the charge cap.
As a result, investing in traditional assets will still be subject to the cap, but if your scheme wants to back something a little more exotic, it can do so without worrying about the limitations of the charge cap.
The DWP suggested that this will make it easier for schemes to back things like new startups or the infrastructure needed for the nation’s transition to net zero, with the promise of higher returns for savers.
And if the investments don’t perform well, the fact that these assets employ performance fees should mean they don’t end up paying large sums for mediocre returns.
Guy Opperman, the pensions minister, was keen to highlight the potential green benefits to the move, arguing that it would address “market barriers to longer-term investing in green markets”.
Protecting savers
Pension trustees, who oversee these schemes and determine where the money is invested, have a big question to ask here.
Just because they can invest savers’ cash into these assets, should they?
After all, there is simply no guarantee that these assets will deliver a return any better than more traditional, lower-risk ones..
And while the performance fees offer some protection, there is still a very real danger that savers end up paying a higher fee for a more mediocre return with these illiquid assets.
What’s more, pension experts have warned that these performance fees can be complicated. If this is going to work, then it relies on transparency from everyone involved.
When is a cap not a cap?
It also raises the question of consistency.
The cap was introduced as an upper limit on what savers can be charged, with the intention that plenty of savers will pay less than that.
It’s not altogether different from the energy price cap in this way ‒ it serves as a last line of defence, but engaged savers and schemes may be able to pay less.
After all, as more and more people sign up to workplace pension schemes, the sheer scale involved would suggest that these charges may start to drop anyway.
But a cap doesn’t really work if there are massive holes in it, and there’s no denying that this idea will blow a bloody great hole into the pension charge cap.
If a cap is going to be effective, then it really needs to be a catch-all.
Just as the social care cap is undermined by the various costs that are excluded, the pension charge cap is severely watered down by this suggested move.