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All The Small Things Small Pots V Standard Charges For Pensions Schemes

All The Small Things - Small Pots V Standard Charges For Pensions Schemes

Tuesday, 29 March 2022

The Department for Work and Pensions (DWP) recently raised the prospect of introducing a single charging structure for workplace pension schemes.

The rationale behind the proposal is something we can support; it will allow people to rate schemes on a single standard and form judgement as to which scheme offers the best value. It would also make the job of the Independent Governance Committee or trustee board easier when comparing other schemes.

The thinking behind the proposal

The DWP thinks that this will be a single percentage-based annual management charge (AMC), where the costs of running a scheme are met simply by taking a percentage of the funds managed. They felt that this offers the best value for pension savers as this concept is easier to understand and it will make it easier to compare costs across schemes. There is a separate DWP project with less industry or government focus that would give everyone a better set of outcomes without the costs of transitioning to one standardised set of charges – the small pot initiative. This article will show that it makes more sense for the DWP to focus on this issue ahead of a standard set of charges.

The small pot initiative

Automatic enrolment has been very successful at getting people saving for pensions, but given the rapidly changing nature of the employment market, this is leaving a large number of small pots around the industry . All policies come with a cost, and even a flat AMC across the industry cannot cover these if the pots are left small.

When automatic enrolment was launched, the DWP also considered the idea of pot-follows-member. This would mean that a member with a small pot would have the money moved automatically to their new automatic enrolment scheme. There were many issues with this, not least in having an agreed standard data exchange to communicate between pension schemes. With the advent of the pensions dashboards, the industry is moving towards a data standard that could communicate across platforms.

Comparing the models

Given that we know how this could be achieved, why should the DWP focus on this ahead of a standardised charging structure? This is probably best achieved with a simple example. A person has two pots of £1,200 in 2 separate schemes. One scheme has a fixed fee of £2.50 and an AMC of 0.5%, which has a rebate of 0.1% when the pot reaches £2,500. The other scheme has a standard AMC of 0.5% . Separately these would give the following values in the first 3 years and after 10 years.

  Scheme 1 Scheme 2 Total
Year 1 £1,200.00 £1,200.00 £2,400.00
Year 2 £1,251.09 £1,253.70 £2,504.79
Year 3 £1,304.46 £1,309.80 £2,614.27
Year 10 £1,751.29 £1,779.48 £3,530.77

If the investor were to combine these into either of the schemes, they would get the following values.

  Combined in 1 Combined in 2
Year 1 £2,400.00 £2,400.00
Year 2 £2,504.79 £2,507.40
Year 3 £2,616.88 £2,619.61
Year 10 £3,559.20 £3,558.96

Overall they are never worse off, even if they combine the scheme with the fixed charge. Initially, they are better in the scheme with the fixed AMC (scheme 2), but over time – as the pot grows larger and the rebate starts to take effect – they are better in scheme 1 with the fixed charge.

The above model is a very simplified example. However, it does indicate that it is difficult to say with certainty that a standardised charging structure will present value for the member. Combining pots will ensure both that the person is no worse off, has a larger pot they are more likely to engage with and will allow pension schemes and providers to become more efficient as they have fewer smaller pots to manage.

A standard charge set will make it easier to compare the costs across a range of pensions. But a standard charge set is not necessarily the best way for the industry to ensure that someone is getting value for money. The best way to ensure that is for the industry to help someone consolidate their savings into fewer, larger pots.

  1. The latest TPR Occupation DC Return shows the average pot size shrank from £18,000 in 2013 to £5000 in 2022, whilst membership (i.e. number of pots) increased from 2.2 million to 23 million
  2. DWP Charges show that qualifying scheme AMC charges dropped from 0.5% in 2016 to 0.48% in 2020 whilst average policy size dropped from £6,002 to £3,938 in the same period meaning the average charge per pot dropped from over £30 to under £19
  3. The table assumes FCA intermediate growth assumption of 6%