1. Introduction
In the October issue of Money Management, page 11, there is a letter from Ms Monica Woodley of the Financial Times which says:
"Adair Turner has cited high pension scheme fees as one of the main barriers to increasing pensions savings...Turner is not considering lowering charges on schemes run by private providers .. but is instead considering the introduction of a national money purchase scheme.
Contributions would be collected through the national insurance system and put into a fund...
There would be a government guarantee that the fund would grow at least in line with the economy...
The scheme could be voluntary, with everyone automatically enrolled but given the right to opt out."
This suggests that a reason for the new scheme is to:
Reason 1: promote saving by reducing costs.
The term "money purchase" is used to describe a kind of pension scheme. But what is being proposed is apparently a saving scheme. According to the Financial Times a scheme will be proposed similar to KiwiSaver in New Zealand: x
"A possible approach is exemplified by KiwiSaver, a scheme recently proposed by the New Zealand government, which involves employees being automatically enrolled as they commence employment. However, they can subsequently opt out. Employers then send a percentage of salary (the default amount is 4 per cent) to the lnland Revenue from where it is channelled to the fund manager of the individual saver's choice. The fund managers involved are ones with which the Inland Revenue has negotiated low investment management fees." (The Ageing Population, Pensions and Wealth Creation (2005), Tomorrow's Company, page 49)
This is a kind of personal pension. There is a market composed of "the fund managers involved" where people do deals described as "the individual saver's choice". People are doing deals in a market of competing providers.
I agree with the idea of a new national scheme, but not one like KiwiSaver. Governments are not capable of successfully negotiating charges with the industry and should not have to. KiwiSaver is like the Swedish Premium Reserve scheme, x and is not the way to reduce dependence on the financial industry. A further reason for a scheme is to:
Reason 2: avoid requiring people to do deals in markets.
The FSA says:
"The subject can be complex and people can find thinking about their long-term financial security dispiriting or even distressing." x
A reason for the scheme is to:
Reason 3: avoid worry for individuals by not requiring them to deal in markets.
I have not so far found what I consider to be an adequate discussion of the cost of annuities. x
Reason 4: avoid the need to buy annuities on the open market.
The scheme would need to be run by an organisation independent of the government. An advantage of the scheme would be:
Reason 5: independence.
There seems to be a growth of GPPs. In my opinion a reason for the scheme is to:
Reason 6: discourage the growth of GPPs.
2. Three problems of the industry
The financial industry regulated by the FSA is often described, especially by the FSA as "the financial services industry". There are the following three problems:
1. The industry is largely concerned with selling "products" rather than providing a service.
2. When it does provide a service it works on a commission or fee-for-service basis - which are both expensive.
3. The industry consists of businesses doing deals. It has an incentive to do as many deals as possible, which causes churning. x
Problem 1
"Taking pension business, for example, Legal and General appear to be paying 6.3% commission for an individual transfer policy. In return, they receive 0.9% of the fund each year in charges from the client.
So, for a £50,000 transfer value, they pay £3,150 to get back £400 each year. For that privilege, they have to pay a sales force and administration team about £1,000 to set the policy up, and you can take off £75 from the annual charge to administer and invest the money. Then they give an extra £25 back to the client each year as a rebate for the excessive charge! So they spend £4,150 to get back £300 each year." x
For an expenditure of £4,150 the Legal and General has earned itself the right to help itself to £300 per annum of the £50,000. The industry has to promote itself to survive which results in problems such as over-bonusing. x
Conclusion 1: Contributions for the new scheme should be collected through the NI system.
Problem 2
An example of fees for service are the fees of Sippdeal. x
| administration fees |
|---|
| Establishment | £100 (£50 if member under age 18) |
| Annual administration | Nil |
| Transfer in from another approved pension scheme | £85 |
| Single contribution | £15 per single contribution |
| Regular contribution | £15 to establish or vary a direct debit |
| Statutory Money Purchase Illustration | £15 |
| Transfer out to another approved pension scheme | £50 plus £10 per line of stock and £20 per unit trust/OEIC |
| Repayment of excess contribution | £25 |
| Benefits |
|---|
| Set up benefits | £75 |
| Pay tax free cash | £75 |
| Regular income payment | £10 per instalment |
| Triennial Review | £75 |
| Lump sum payment on death | £75 |
| Annuity purchase | £75 |
|
Notes All fees are subject to VAT in addition. All charges will be deducted from your e-sipp deposit account. | |
Every time you receive a regular income payment you have to pay £10. Every three years there is a "review" costing £75. Any changes to the SIPP can only be made, on your instructions, by Sippdeal. All such changes result in charges. SIPPs are described as "do-it-yourself". But whenever you decide to do something there is a charge. You have to pay over-the-odds for dealing: "All Sipp providers make some money from dealing charges and stockbroking fees." x
In a survey of the charges of over 50 Sipps, of the Financial Adviser, of 8th October 2005, Sippdeal is one of only three that does not have an annual charge, starting with AJ Bell with £480. The other two are the Alliance Trust x and Hargreaves Landsdown x which says for its "low cost" SIPP:
"For securities, cash and those funds that do not pay renewal commission, an additional fee of 0.5% + VAT per annum will apply (maximum £200 + VAT per annum)."
0.5% per annum does not seem very low cost.
There is a analogy with our NHS, which is less expensive than health care in the US because doctors do not work on a fee-for-service basis.
Conclusion 2: The scheme should not charge fees for everything it does.
Problem 3
This website is particularly concerned with churning. x Paul Augur and Paul Myners say:
"Elimination of costly and frequently value destroying trading could have a positive impact on computed pension deficits if actuaries can be persuaded that they will continue - a significant prize to be pursued by trustees and fund sponsors armed with important new information. But this assumes that trustees are up to the task." x
The turnover of pension funds is given on this website. x The values are quite high. It seems that trustees are in fact not up to the task.
It also assumes that there are trustees! This trading produces costs and charges outside the stakeholder cap on charges. With the result that choice of stakeholder products is not really meaningful.
The First Report of the Pensions Commission discusses dealing costs (page 218). It says the Commission will be doing more work on the topic. It has only discussed averages so far, and will hopefully be looking at the spread. Paul Augur and Paul Myners say:
"For some funds commissions can be larger than the fee paid for fund management itself."
Just looking at averages seems inadequate. For example, on average annuities are secure. But nevertheless Equitable Life with-profits annuities are a problem.
Conclusion 3. The portfolio turnover of the scheme should be low.
Conclusion 4. The new scheme should have trustees.
2. "Super duper - more choice, lower returns" x x
Without a new national scheme, we are heading towards 401(k)-type schemes in the US which consists of collections of mutual funds.
"We regularly read of plans that have expanded their menu of choices to literally hundreds of mutual funds. Indeed, so intense is the "rush to choice" that now many plans allow participants to open brokerage accounts where they can speculate on stocks and funds daily! .. The "more is better" approach to 401(k) options is folly, not wisdom. x
There is extensive choice also with the Australian super funds, and equally extensive arguments about fees x such as Super funds skirt the truth on fees: x x Not-so-super fees and charges, x Costello faces call for super fees shake-up: x
"Australia's superannuation system has evolved into an industry in which the main product is not investment expertise, but range and complexity of choice." x
The extensive choice of funds in the Swedish Premium Reserve scheme has also not been successful. x
The "simplified" rules being introduced next year allow SIPPs to be invested in everything from residential property to vintage wine. x They seem like a recipe for choas - more choice, more confusion. Government pension policy has been largely based on "informed choice":
"Empowering individuals to make real and informed choices on working and saving for retirement is fundamental ... improve the range of choices on offer through the stakeholder pension ... activation, education and information x
What about benefits? A greater choice of funds has to be paid for, with the result that there are lower benefits. x
Conclusion 5: The new scheme should not provide a choice of funds for younger members.
Pension schemes sometimes provide a choice of funds of varying degrees of risk so that members can choose one in accordance to their "attitude to risk". In my opinion this is such a subjective quantity that this choice is more of an unhelpful dilemma, at least for younger members.
3. A marketing tool
What is replacing DB pension schemes? The main possibilities seem to be:
1. industry wide-DC schemes,
2. DC occupational pension scheme,
3. GPP or group stakeholder,
4. Group SIPP,
5. an individual personal pension or other form of saving.
GPPs seem to be "in practice a marketing tool and not actually a separate product". x The ABI says there is (in 2005) a growth of GPP business.
"We are particularly encouraged by the growth in employer-sponsored Stakeholder Pensions and Group Personal Pensions." x
"Group personal pension plans usually offer policyholders a choice of funds in which to invest contributions." x Who looks after portfolio turnover and dealing costs for these funds if there are no trustees? For this reason the FSA is proposing the creation of "investor representatives" x for GPPs and other savings "products" which do not have trustees. But they are not like trustees, because:
"The trustees are independent of the investment manager and have fiduciary duties towards investors or beneficiaries."
There has been a trend to offer SIPPs with GPPs. x
4. 401(k) plans
GPPs are a means of marketing funds. There is a similar situation with 401(k) plans in the US. These are largely invested in mutual funds."In a 401(k) plan the employee will usually be offered several investment options from which to choose. Almost always these options are mutual funds. Mutual funds charge retail management fees for 401(k) accounts, usually from 100 to 300 basis points--1% to 3%--of the assets in the employee’s account every year! These are truly exorbitant fees compared to fees charged to traditional defined-benefit pension plans: 7 to 20 times higher.
It is these exorbitant fees that make Wall Street so enthusiastic about converting the employer financed defined-benefit pension system into an employee financed 401(k) savings system." x
There are numerous articles about 401(k) fees on the 401(k) Help-Center x Such as:
"the foundation for today's retirement savings chaos and hidden fee crisis ... Participant account balances will continue to groan under the strain of industry fabricated fees for its own benefit, not the participants." x
Conclusion 6. We should not go down the GPP - super funds - 401(k) route.
5. On retirement
On retirement members should not have to buy annuities on the market. The scheme should itself provide annuities, and an income drawdown option.
Conclusion 7. The scheme should provide annuities and an income drawdown option.
6. Conclusion
Useful general principles seem to be:
People like having their own pensions pot.
They do not like having to look after it.
They do not like having to give it up when they retire, such as to buy an annuity.
I suggest that the proposed new national scheme:
has members and is owned by the members,
is controlled by trustees,
manages investments in-house or by mandates, always retaining ownership,
keeps track of who owns which units,
corresponds with unit holders,
provides annuities and income drawdown plans.
October 2005
Stephen Wynn