Employers are right to focus on charges when it comes to selecting their Auto Enrolment pension scheme provider. Low charges and a high quality investment proposition are possibly the two most important factors on the growth in your employees’ auto-enrolment pot.
So it is important to watch out for pension schemes that catch the eye with what look like low charges at first glance, but that contain far higher hidden costs buried in the small print.
These schemes operate what in the pension industry are politely known as ‘active member discounts’. An active member discount sees current employees charged a lower annual management charge (AMC) than former employees who have subsequently left the organisation. The more accurate name for these charging structures is ‘deferred member penalties’ because of the way they cream hundreds and even thousands of pounds in charges from former members of staff.
The providers who offer schemes with active member discounts argue there is nothing wrong with them because former employees are free to move their pot to another scheme if they want to. We think these schemes are yet another example of financial services providers relying on inertia to screw more cash out of unwitting members of the public.
It’s like the table-topping ISA savings deal that give virtually no interest once the initial bonus period is over. Most former employees will never get round to switching their pot to another provider and will instead often see the AMC on their pension more than double.
The numbers may sound small, but even an increase in AMC from 0.5 per cent to 0.8 per cent will, over 30 years, reduce a former employee’s pot by 6 per cent, assuming investment returns of 9 per cent. However, it is not uncommon for these increases in charges for deferred members to be much higher than this example.
Some providers even offer active member discounts that will penalise an employer’s current staff. These schemes increase charges where an existing employee joins and contributes for a few months and then chooses to leave after the one-month opt-out period, within which a full refund of contributions can be made, has expired.
This inequality creates a reputational risk for the employer. A situation where employees who are still contributing into their plans are charged at a lower rate than those who have chosen to stop contributing will, rightly, be perceived by staff as unfair.
It’s not just NOW: Pensions that thinks different charging structures for different members of a pension scheme is a bad thing. The Pensions Regulator is on record saying it “does not view active member-only discounts as being fair, and therefore, acceptable”.
The Department for Work and Pensions is no fan of the practice either. Its regulations require charges to be ‘appropriately and competitively priced for active and deferred members’. So it is hard to see how charging former employees more is justifiable when if anything, the cost of managing their pensions is lower, not higher than for current employees because there is no administrative cost of collecting and processing contributions and buying additional units.
Auto Enrolment places a big responsibility on employers to make sure workplace pension schemes are well governed, and that duty extends to former employees just as much as to existing ones. We know most employers want to do right by all staff, both existing and former employees. Avoid active member discounts and you will have done the right thing.