The government has launched a review into whether the pensions charge cap should be lowered to ensure savers in workplace pensions are getting value for money.
The cap, which is the limit on fees that can be charged in defined-contribution (DC) schemes used for auto-enrolment, stands at 0.75% and applies to all scheme administration fees and investment costs.
The Department for Work and Pensions (DWP) wants to find out whether the charge cap should be reduced, and whether other fees that schemes apply should be included in the cap to make costs clearer.
Here, Which? explains how the charge cap works, looks at how the rules could change and how much you could potentially save.
How does the pensions charge cap work?
The charge cap applies solely to qualifying schemes for auto-enrolment, meaning it meets certain minimum standards before an employer can automatically enrol workers.
It only applies only to members in the default fund, which offers an appropriate investment strategy for people who can’t or don’t want to make their own pension investment decisions.
It doesn’t apply to members who make an active choice to select a different fund.
There are three different types of charging structures schemes can impose:
- a single percentage fee (of your total pot) capped at 0.75% of funds under management annually
- a percentage charge on each pension contribution you make plus an annual percentage charge of funds under management
- an annual flat fee decided by your provider plus an annual percentage of funds under management charge.
Find out more: what is a company pension?
How could the rules change?
The pensions charge cap was introduced in 2015.
The government reviewed the cap in 2017 and found it was working as intended.
However, it committed to looking at the level and scope of it again this year to ensure pension scheme members are getting value for money.
The government hasn’t specified how it may change the rules exactly, but here’s what might be considered.
The government hasn’t proposed a specific level the cap should be reduced to.
However, the cap has been fairly controversial, and many pension experts, including former pensions minister Steve Webb argue that there should be a maximum annual charge of no more than 0.5%.
Which? also campaigned back in 2015, to lower the cap to this level, and to roll it out to cover all new and existing workplace pensions, rather than just AE schemes.
The DWP is considering including transaction costs and a small number of other charges into the cap, in order to improve the transparency of charges.
These include costs incurred by investment funds when assets are bought, sold or lent by the fund, known as ‘transaction costs’, and fees associated with life assurance products, which are sometimes included in scheme benefit packages.
Industry experts have previously argued that there’s been a lack of adequate transparency in the area of transaction costs to give any indication of what they amount to.
The government is also looking at the effectiveness of flat fees.
Typically, a flat fee structure would only really benefit those with the largest funds who contribute over a number of years, provided the fee is low.
Schemes with flat-fee charging structures may benefit from reduced vulnerability to economic shocks, such as that experienced during the COVID-19 emergency.
However, the problem is that individuals who are with a scheme for a short period of time could end up paying a higher charge.
This is because the fee is levied on the pot each month irrespective of whether contributions continue to be paid.
According to the DWP, this means that many of these savers could have the balance left in their fund charged down to zero before they reach pension age, even with a reliable annual investment return.
- Find out more: should I join my company pension scheme?
How much are you paying for your pension?
While the cap is set at 0.75%, the annual investment fee may sometimes be higher due to costs incurred by managing the underlying investment fund. In some cases, total costs may amount to up to 1%, though this is quite rare.
According to the DWP’s latest data from 2017, average charges are typically between 0.38% and 0.54% depending on the scheme type. This doesn’t include transaction costs or other charges.
However, there are some providers who continue to charge near to or at 0.75%. These are often, but not exclusively, smaller schemes that are less able to take advantage of the most competitive rates on the market.
For schemes with less than 100 members which qualified for auto-enrolment in 2017, the DWP says each member of staff typically paid between 0.61% and 0.72%.
It’s important to note that there are other fees which your provider may charge, such as a service or policy fee, which is sometimes hidden.
- Find out more: how DC pensions work
How much could you save with a lower charge cap?
While the government isn’t likely to drastically reduce the cap, any change could still make a substantial difference to your overall pot over time.
How much you’d save depends on the charging structure your scheme imposes.
The table below outlines the maximum a member would pay under a single percentage fee charging structure, which would be based on the total value of your retirement pot. This doesn’t include any underlying charges.
As you generally build your pension over time, the charges would typically increase as your pension grows. Although, the contributions you pay would usually be much more than the amount you’re charged, meaning your overall pot would keep building.
It’s more difficult to say how much less you could pay under a contribution or flat-fee structure, as it depends on how much the scheme charges per year.
- Find out more: how much will I need to retire?
Can I switch to a pension scheme with lower charges?
For most people, staying in a workplace pension is a good idea, particularly as your employer must contribute to it.
Stakeholder pensions generally tend to be cheaper and more flexible. However, they have limited investment choice, and generally only include low-to-medium risk investments, meaning your returns may be lower.
Meanwhile, Sipps offer you the chance to choose your investments and are a great option for people who want to gather all of their pensions into one pot before they retire. On the other hand, you must be comfortable with making your own investment decisions.
If you do decide to switch, beware of exit penalties on your existing policy, and consider any benefits the scheme you’re in offers to ensure you don’t lose out.
The type of pension you choose should be suited to your individual needs so if you wish to switch, it’s really important to take financial advice.
- Find out more: how to get pension and retirement advice