‘Workplace pension lottery’ hits savers with higher fees

First published 05 August 2019 • Updated 01 August 2019

Many members of workplace pension schemes are losing out on thousands of pounds due to variations in provider fees, according to a new comparison index. Differences in pension default funds also give rise to significant inequalities. Article by Nick Green.

Savers hit by workplace pension lottery

Some UK workers may be ending up thousands of pounds worse off in retirement because of the differences in workplace pension management fees, according to a recent study. Meanwhile, many other pension savers are missing out thousands more in potential growth because their pension savings are still held in their scheme’s default fund, when more suitable options may be available.

The Auto Enrolment (AE) Cost Comparison Index produced by NOW: Pensions reveals a dramatic variation in the charges made by pension providers. Annual management fees are in some cases more than double the cheapest options (such as NEST, the government-backed workplace pension scheme), and some providers make additional charges. Although management fees are typically well below 1 per cent of pot size, they can still make a significant dent in the size of a pension pot over 40-plus years of saving.

Provider

Annual Management Charge (AMC)

Additional Charge

Value after 20 years

Effect of charges

-

No Charge

-

£76,380

NIL

NEST

0.30%

+ 1.8%

£72,680

£3,700

Aegon, LGIM

0.50%

-

£72,486

£3,894

Creative AE

0.40%

+ £2.00 pm

£72,469

£3,911

Smart Pension

0.75%

-

£70,636

£6,636

A small variance in fees can make a big difference

The AE Cost Comparison Index has calculated the effect of provider fees on otherwise identical pension pots over a 20 year period. This assumes an initial salary of £28,000 which grows by 2.5 per cent annually, investment growth of 5 per cent and an 8 per cent annual contribution.

These differences in provider fees can have an even more dramatic effect on transfers in from another pension. According to the Index, a transfer-in of £28,000 from another pension would cost a total of £16,056 after 20 years, assuming an AMC of 0.75 per cent. By contrast, with NEST the total cost would be only £8,009 after 20 years – a difference of more than £8,000.

Policy director at NOW: Pensions Adrian Boulding commented, ‘The AE Cost Comparison Index clearly lays out the devastating effect high fees can have on retirement savings. We hope our analysis will encourage employees to shop around for the AE provider that suits them best and look at fee structures over the long-term, to ensure they are getting the most out of their hard-earned money. We also recommend that all savers consolidate their funds, to benefit from economies of scale where providers offer these.’

Millions are also losing out in default funds

Another hidden cost to workplace pension scheme members can be the loss of growth due to having their money invested in unsuitable funds. A worker enrolling in a workplace pension scheme (usually an automatic process) will have their contributions invested in that scheme’s default fund unless they specifically request otherwise.

A default fund is a portfolio of investments designed to broadly suit the largest number of employees, whatever their age or circumstances. This means it is attempting to be equally suitable for a 20-year-old employee at the very start of their career, as for a 65-year-old soon to retire. Therefore it can only be moderately suitable for either of them, and both could probably find more suitable options.

Furthermore, default funds vary greatly from scheme to scheme. A study of the top 20 providers by the Tax Incentivised Savings Association (Tisa) found that the best-performing default fund over the past three years has delivered 11.9 per cent annual growth, while the worst has delivered just 3.4 per cent. This reinforces an earlier 2015 study by JLT Employee Benefits of the top 10 default funds, which showed growth ranging from 3.5 per cent to 9.5 per cent. Stretched over the course of a career, this kind of disparity can translate into a huge difference in the size of a pension pot. Even an average difference of just 3 per cent over 40 years would mean a difference of over £270,000 in a pension pot (assuming £28,000 salary contributing 8 per cent over 40 years).

It’s worth noting that these figures only consider default funds. Most schemes offer a variety of fund types, each one tailored to a different type of investor or career stage. For example, a worker near the start of their career may be comfortable using a higher-risk fund, to pursue aggressive growth in those early years and give their pension pot some early momentum. Savers can then move by steps into lower risk funds as their career progresses, finally choosing the most stable funds shortly before retirement – depending on the advice of their financial adviser.

These two sets of findings are a reminder that workers can benefit from taking a more active interest in their workplace pension and how it works, and may be losing out by not doing so.

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About the author
Nick Green
Nick Green
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.