The Pensions Regulator has challenged us to establish what can practically be done for staff with DC pensions.
In my most recent post I argued that an employer has an obligation to tell its staff the truth and that the honest truth about DC pensions is that pound for pound they will deliver considerably less than DB pensions, that the majority of staff are probably overestimating the value of their DC pensions and that even if the employer has done all it can to maximise the efficiency of its DC arrangements, staff should be considering reorganising their finances to comitt considerably more to retirement savings than up till then.
That’s the tough part.
The easy part is getting to grips with the DC plan itself. I’ll start with a table of numbers which come from a recent peice of work we did for a charity.
|SMPI (1% expenses)||SMPI (0.55% expenses)||Current|
|30 – 39||21.5%||6.5%||15.0%||19.0%||6.5%||12.5%||16.5%||5.3%||11.2%|
|40 – 49||29.0%||6.5%||22.5%||25.5%||6.5%||19.0%||16.5%||5.3%||11.2%|
The percentage figures in the boxes are the estimated percentages of salary that need to be paid into a pension to provide certain defined outcomes. I need to add that these are only estimates and the actual outcomes will depend on market returns.
The current arrangement on the left is a defined benefit pension scheme into which the employer is paying 11.2% of total salaries and staff a further 5.3%.
The current DC scheme which is a stakeholder pension where the pension costs are 1% of the accumulating pension fund requires roughly equivalent pension contributions for those under 30 but considerably more in contributions as staff get progressively older. If you average the costs across the range of employees of this charity you find that the average cost of providing the same estimated outcomes as the DB plan has gone up from 16.5% to 24% telling us that even a stakeholder pension is about 50% less efficient than a DB plan.
The middle set of numbers shows what happens when the member charge reduces from 1% to 0.55%. By making the plan more efficient, the Charity could b ring down the equivalent funding cost by about 13%. This plan would still be a lot less effecient than the current DB plan but it’s a whole lot better than the current DC arrangement.
Those of you who’ve followed me through this boring bit should be feeling a little surprised. If you consider that there are DC pension plans with member charges of around 0.1% pa then you can see that some employers are providing DC plans that are 26% more efficient than those written at the stakeholder 1%pa. My friend Jeroen Wilbrink tells me that historically the Dutch collective DC plans have charges on the accumulation funds of 0.1% so to answer the Regulator’s question – an 0.1% TER looks the floor for DC charges, with a 26% enhancement possible relative to stakeholder charges.
With NEST looking to establish its charge at 0.30% (I’ll ignore the contribution charge which I assume is a temporary blip), we can see that there is scope for large employers to provide considerable efficiencies beyond the capacity of NEST. This may seem counter-intuitive since NEST is likely to become the largest DC plan in the country in only a few years, but it does make sense. NEST’s charge represents the cost of dealing with small employers and many of its fixed overheads (such as its payroll collection system) will be considerably more expensive than for the larger employers.
I will (for once) leave aside the issue of decumulation (where there are other efficiencies to be made). My point in this blog is that if employers are going to be ruthless and drive down the costs of their staff’s DC accumulation, then outcomes can be improved from the stakeholder charging benchmark by between 13 and 26%.
In order for these savings to be increased, we need to accept that DC provision will be concentrated around a small number of super insurers who are up to the job of providing efficient product, that adviser commissions and other unnecessary advisory fees are a thing of the past and that there is a collective will among employers to negotiate directly or through corporate brokers to get best value for their staff.
That’s a big ask and a big challenge,
- Tell them the truth (a ridiculous notion) (henrytapper.com)
- What really matters -DC outcomes (henrytapper.com)
- The State can take longevity risk. (henrytapper.com)
- Has the DB model failed or just fallen out of favour:? (comprehensivepensiongovernancegwahl.wordpress.com)
- A blueprint for DC pensions (henrytapper.com)