NEST gets charging regime – and it’s pretty good
NEST is the new low-cost default pension scheme for employers who do not have alternative arrangements when the new duty on employers to auto-enrol their staff and make pensions contributions starts to roll out in 2012.
We already knew a lot about how it will work, but there has been one big gap. But today we have learnt what its charging structure will be.
The industry standard way of charging for a pension is an annual management charge (AMC). This is a percentage that your pension company will take from your pension pot each year. Stakeholder pensions are allowed to charge up to 1.5% for the first ten years, and after that 1%. This is about the best value that an individual can get.
Employers who run big DC schemes for their staff can do better than this as they do not have the marketing or administration costs of a retail pension company selling personal pensions to ad-hoc individuals.
Charges can make a big difference to the size of your pension. One study shows that a difference between charges of just 1% can reduce the value of a pension pot by 24% over 40 years.
It has always been a key objective for NEST that it should keep it charges down. The Turner Commission said it should be possible to run such a scheme with an AMC of 0.3% – significantly lower than personal pensions. And this is what NEST has announced today.
This is good news.
But on top of this, there is to be a contribution charge of 2% to help pay the set up costs. This is perhaps not so welcome, but is still sensible.
Setting up a new national pension scheme is not a cheap process – especially considering it has a public service obligation to provide pensions to every employer however small, disorganised or even un co-operative they might be.
Ar the same time pension contributions are going to build up very slowly in NEST due to what is known as staging and phasing.
It has always been part of the 2012 consensus that contributions should be phased in rising in one per cent steps. This is not perhaps our favourite bit, but as well as providing some comfort to employers it may help staff get the savings habit. Staging the introduction of auto-enrolment is obviously preferable to a big-bang date when every employer in the country has to start auto-enrolling.
But put staging and phasing together with the Treasury’s reluctance to start contributing the extra tax relief that millions of new savers will require means that full contributions will not flow until 2016. (Originally it was 2015 but an extra year’s delay was announced in the pre-budget report.)
This means that the contributions on which the AMC will be charged will build up very slowly, and produce very little income in the early years.
EU competition rules mean that the tax payer cannot subsidise NEST start-up costs and that therefore they need to fund their early years through borrowing.
Defraying the costs of borrowing through an initial additional contribution charge makes sense and at least ensures that loan charges do not spiral in NEST’s early years. 2% of contributions is perhaps a little more than we had hoped but is not unreasonable – and will be less than the tax relief that savers get.
It still leaves the overall charges looking pretty like those that would be paid by members of reasonable employer-backed schemes, and still substantially below stakeholder charges.
But I would worry if they went any higher as that would start to eat into one of NEST’s strong selling points.
Inevitably today’s decisions will be criticised – and probably from both sides.
Some in the industry will probably complain that they are too low and that there is secret state support for NEST.
This is what I would call cheek. NEST serves a very strong public policy purpose of remedying the clear market failure of the pensions industry to provide pensions for low to moderate earners. Given that millions of savers will be lifted clear of means-tested benefits by NEST there is every reason for tax payer support. But EU rules prevent it – and they are pretty tough.
Others will worry that the charges are too high, as the NAPF and Towers Perrin do in the BBC report.
Like the NAPF, I regret the need for the initial contribution charges too, but Towers Perrin overstate their case.
“people near retirement who only save in NEST for a short time could face the sort of charges that the Government said it was creating NEST to avoid.”
This is not true. Even the combination of charges will be lower than those for stakeholders. And people saving will still get the benefit of employer contributions and the tax relief. If they are very near retirement and have no other savings then they will probably take it as a lump sum under trivial commutation rules.
For every £50 they contribute they will still get £100 back plus any investment growth less £1 contribution charge and 0.3% AMC for every year that the fund is held.
That looks like a pretty close to a buy-one-get-one-free deal to me.