The consumer watchdog, the Office of Fair Trading, says some charges – especially on older pensions – are far too high.
There are several reasons why people don’t set aside money in a pension and one of them is that they’re worried about high charges. Today the OFT has published the results of a study into workplace pensions. It says that some people, especially those in older pension contracts, are losing out by paying high charges. It also said that smaller firms may not know how to choose the best pension.
What the OFT found
The OFT started looking at workplace pensions in January. It didn’t look at ‘final salary’ or other salary-related pensions, because the onus with this type of scheme is on the employer to make sure they pay out what they promised.
Instead, the OFT only looked at ‘defined contribution’ pensions, where the employer promises to pay in a percentage of the employee’s salary and the amount you get at retirement depends on how well the investment has performed (as well as how much has been paid in).
It was concerned that competition alone may not be producing the best result for employees who’ve saved into a pension. In its report, it said:
- Employers may not always choose a pension scheme that delivers value for money. That’s because employers may not always know what to look for or they may not care sufficiently about the deal their workers get.
- Pensions are so complex that it can be hard to work out which is the best/right one. The OFT said that both the charges and the quality of a product are difficult to assess and whether or not you’ve picked a good pension may not be apparent for some years.
Because of the way compound interest works, the effect of even a low charge can add up over the years. The OFT says that an annual charge of 0.5% can reduce a pension fund’s value by 11% over someone’s working life, and a 1% annual charge can reduce its value by 21%.
How much is a fair charge?
Pension companies have to charge something for investing your pension money. But too many of them charge too much and they make the charges more complex and difficult to compare than they need to be.
The OFT said that for pension schemes set up before 2001 (when the previous government introduced ‘stakeholder pensions’ which had a cap on charges of 1.5% for the first 10 years and 1% a year afterwards) there were 18 different charges that could be levied. These days, most pension fund companies include their charges in an annual management charge or AMC.
The problem is that not all charges are wrapped up in the annual management charge, and the costs associated with buying and selling shares within a pension fund often aren’t listed at all. That means it’s difficult for employers, never mind for employees who rely on the pension for their retirement, to work out what they’re being charged.
The OFT was also concerned about ‘two tier’ charging, where pension companies charge active members (people who are still paying into their pension scheme) less than those who’ve left the company or who’ve decided not to carry on paying into the pension. These extra charges can add almost 0.5% a year onto the annual costs.
The OFT said that in some cases it cost the pension companies less to deal with the administration for someone who wasn’t paying into their pension scheme any longer, so it wasn’t necessarily logical that they should be charged more.
Lack of switching to a better deal
Pension charges have come down in the last decade or so. There’s no doubt about that. The problem is that too many people are still stuck in old pension schemes where charges are high. In some cases it may be difficult for their employer to switch them to a new pension scheme because their old one may impose exit charges. Alternatively, switching may need all pension scheme members to agree, which in itself could be an expensive exercise.
The OFT has stopped short of recommending a cap on charges. Instead it wants to see:
- Improved governance: so that there’s better control and improved decision-making about pensions.
- Clearer information about charges. Pension providers should be able to produce a single charge (in pounds and pence) that people who are in the scheme will have to pay every year. This should aim to include the majority of the costs someone will pay (although the costs of buying and selling investments held within the fund won’t be included).
- A review of old pension schemes: the Association of British Insurers will review pension schemes set up before 2001 and all of those set up after 2001 where the annual management charge is more than 1%.