Workers might have to fork out more than 0.75 per cent to save into pension funds under plans to open them up to risky – but potentially more rewarding – investments.
The current charges cap for ‘default’ funds, used by the majority of workers, could be eased in order to exclude performance fees.
Charges of as much as 20 per cent can be levied for outperformance on long-term, and therefore illiquid, green infrastructure, private equity and venture capital projects.
Retirement savings: People with jobs are automatically opted into their employer’s pension scheme unless they actively object
The Government wants to encourage more pension money into such high-risk UK-based investments, and says they could provide better returns for savers as part of a balanced portfolio, plus help sustain employment, communities and the environment.
However, financial experts say pension schemes will have to justify the risk and expense of exceeding the 0.75 per cent cap, and homegrown infrastructure projects will have to compete on their merits with similar ventures in the rest of the world for UK pension savers’ money.
People with jobs are automatically opted into their employer’s pension scheme unless they actively object, and their money is placed in its ‘default’ or standard investment fund and stays there if they don’t choose any of the alternatives usually available.
The vast majority, around 90-95 per cent, stick with their employer’s default fund, whether it really suits them or not.
Last week, regulators announced that people saving for retirement outside workplace schemes, like the self-employed, could be offered simple new ‘default’ pension funds.
However, charges would not be capped at 0.75 per cent as they are in similar work funds.
Today, the Department for Work and Pensions announced a consultation on exempting ‘well-designed’ performance fees from the workplace fund charges cap.
The retirement outcomes of individual pension savers should be the primary goal of a pension scheme, rather than the need to finance risky infrastructure projects
Becky O’Connor, Interactive Investor
Pensions Minister Guy Opperman says: ‘We are proposing to increase the flexibility trustees have to access a range of assets whilst ensuring members are protected from predatory charges.’
The consultation document explains that although some illiquid assets can be accessed without paying performance fees, they are often imposed to gain access to ‘the most illiquid, higher risk but potentially highest potential gross return investments’.
It goes on: ‘The reasons cited by investment managers for these higher fees is that such costs are often justified by the superior returns that may be achieved and that the investments can often involve specialist active management, extensive research, niche expertise and greater ongoing engagement with business managers.’
One potential sticking point is that performance fees are often charged to investors at the end of the life of a fund, but accrued at intervals across the investment period.
The DWP has suggested using a five-year moving average of performance fees to make them fit with charges on a default work pension fund.
Tom Selby, head of retirement policy at AJ Bell, says: ‘As automatic enrolment pension schemes build scale, you’d naturally expect charges – and potentially the 0.75 per cent charge cap – to fall.
‘However, with the Treasury desperate to drive investment towards higher risk UK projects, in particular infrastructure, the DWP wants to move in the other direction by watering down the cap.
It is essential that members continue to be protected… The charge cap continues to serve an important role
Guy Opperman, Pensions Minister
‘This would potentially make it easier for schemes to invest in vehicles operating a traditional ‘2:20’ charging structure – where upfront fees are 2 per cent, with the fund manager raking in 20 per cent of any outperformance above a certain agreed level.
‘It’s important to note the 2 per cent element of such a charging structure would continue to be included in the charge cap under the plans.’
Becky O’Connor, head of pensions and savings at Interactive Investor, says of the plans: ‘The theory makes sense, particularly amid forecasts of lower long term stock market growth and the impact on pension pot sizes on retirement, but whether it works out in practice and the returns end up justifying the higher charges remains to be seen.
‘There’s a risk that the promised returns fail to materialise, despite the higher fees, which would look like pension scheme members paying middle men more, for less. So it will be very important that higher fees are only charged when it can be justified.
‘Keeping fees as low as possible in the absence of stellar investment growth can make a big difference to people’s retirement outcomes.
‘It’s important to bear in mind that the retirement outcomes of individual pension savers should be the primary goal of a pension scheme, rather than the need to finance risky infrastructure projects.’
Brenda Kite, a pension expert at Hymans Robertson, says: ‘We do not believe that allowing performance related fees for illiquid assets within the charge cap will be the ‘game-changer’ the government hopes.
‘Performance related fees are difficult to administer in defined contribution schemes as well as raising questions of fairness from one member to the next.
‘It also has to be remembered that the UK will have to compete on its merits with the rest of the world for a share of UK pension funds’ investments in illiquid assets.
‘We feel that the Government needs to look at other ways of incentivising investment in this area of the UK economy.’
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