The Department for Work and Pensions has concluded that a flat-fee structure implemented by some master trusts does not provide “adequate protection”, especially for lower earners, and is proposing an application limit to protect small pots.
The government launched a review of the default fund charge cap and standardised cost disclosure on Thursday. It asked for input from the pensions industry on a series of questions, such as whether the current 0.75 per cent cap for defined contribution default funds should be lowered, and whether transaction costs should also be included under the cap.
However, the DWP is proposing changes for flat fees – which some master trusts apply in combination with an annual management charge under the cap, for administration purposes.
Government officials stated: “The flat-fee structure in its present form does not provide adequate protection, particularly for low earners and other groups that have traditionally been excluded from pension saving.”
The real challenge will be setting such a de minimis at the right level to ensure pots don’t get eroded to zero, while making sure the economics stack up
Darren Philp, Smart Pension
Pots can be eroded to zero
The problem with the flat-fee structure – which was raised by the work and pensions committee in February 2019 – is that for individuals who save for a short period of time with a scheme could end up paying a higher charge, since the fee is levied on the dormant pot each month irrespective of whether contributions continue to be paid.
“Many of these savers could have the balance left in the fund charged out to zero before they reach retirement, even with a reliable annual investment return,” the DWP stated.
On the other hand, a flat fee can be beneficial for savers with bigger pension pots, which is why the government is not considering a complete ban on this charge.
Even if limited to dormant pots, a ban could “eliminate competition and push charges upwards, while restricting choice for employers”, which “could lead to poorer retirement outcomes for scheme members”, the DWP stated.
To prevent small pots from being eroded to zero, the government is considering measures that will set a minimum pension pot size before a flat fee can be charged.
For example, providers would only be able to charge a £5 fee or less to savers with pots above £100, a fee of more than £5 but equal to or less than £10 to individuals with savings above £200, and so on.
However, the government still has a number of questions about how any such mechanism might apply – such as if it should apply to all members or just the ones who are deferred, if there are any issues that would make it difficult to introduce such limits, among others.
“We will work with stakeholders on the detailed application of any measures taken forward following this call for evidence,” it stated.
Master trusts caught up by new mechanism
Now Pensions, which has been the target of criticism on this matter, will be one of the master trusts to be affected if such a mechanism is introduced.
The master trust charges a £1.50 admin fee a month per member on top of a 0.3 per cent AMC.
When it was first confronted about this by MPs at the WPC, the provider argued that separating the fees is more transparent, as “it is clear to members how much they are paying for investment management, and how much for scheme administration and communication”.
The People’s Pension – the second biggest master trust in the UK after Nest – announced in April that it was introducing a similar structure, with three components: an annual fee of £2.50, deducted during each scheme year, a management charge of 0.5 per cent, and a rebate on the latter of 0.1 percentage points on savings of more than £6,000 and 0.3 percentage points on savings above £50,000.
At the time, the provider took the view that the cross-subsidy from active savers to the deferred pots needed to be reduced, which is why it decided to introduce the fee structure.
Gregg McClymont, director of policy at The People’s Pension, said: “We’ve long supported the charge cap and were the first master trust to publish its investment costs. We’re keen to work with the government on this important consultation.
“While auto-enrolment has been a success, it has also contributed heavily to the 18m dormant pension pots – the majority of which are very low in value.”
Mr McClymont continued: “In The People’s Pension, active members with modest pension savings continue to cross-subsidise millions of dormant pots that are too small to provide a retirement income. We welcome the review, but solving the dormant pots challenge of auto-enrolment is crucial.”
Adrian Boulding, director of policy at Now Pensions, proposed that a mechanism as suggested by the DWP should only be introduced for the “small pots that fall into the cracks”, and cannot be reunited with their owners.
He said: “I think the critical thing that we actually need to address is how we reunite small stranded pots with their owners, so they can have a pension they can rely on when they retire. The behaviour that we see is that members cash in these small pots at time of retirement.”
Smart Pension, which has a similar model for some employers – with an admin fee up to £1.25 a month in addition to a fund-based AMC of 0.25 per cent – has already introduced its own limit, with the flat fee cutting out when pots drop below £500.
Darren Philp, director of policy and communications at the pension provider, supports the DWP’s proposal in this area.
He said: “Not unexpectedly, auto-enrolment is creating lots of deferred small pots, which are becoming an increasing headache for providers to serve in a cost-effective way. The DWP is right to highlight concern about small pension pots being eroded to zero and to examine the impact mitigation measures might make.”
The People’s Pension introduces ‘criticised’ annual charge
The second-largest master trust in the UK changed its charging structure and introducing an annual fixed fee, a model that other providers operate but which has been heavily criticised by experts.
However, Mr Philp noted that given the scheme economics of running small pots, the government “will need to tread carefully on this one, but some form of de minimis, like we have introduced, is a sensible and proportionate approach”.
“The real challenge will be setting such a de minimis at the right level to ensure pots don’t get eroded to zero, while making sure the economics stack up,” he added.
“Above all, though, what we need is a solution to the small pots problem and policy interventions that mitigate this side effect of auto-enrolment.”
