Charges and governance in pension schemes and particularly in workplace pension schemes have been the subject of debate and scrutiny in recent years.
From 6 April 2015, a charging cap of 0.75% will apply to default arrangements. This has been introduced by the Occupational Pension Schemes (Charges and Governance) Regulations 2015. The change comes following the DWP's governance review of workplace pensions as well as the Office of Fair Trading study which identified concerns around employees' lack of understanding around pension products and particularly charges.
The cap will apply to the default arrangement of a relevant pension scheme. A relevant pension scheme is an occupational pension scheme which provides money purchase benefits. There are some exceptions including schemes where the only money purchase benefits provided are additional voluntary contributions. Non-compliance will be subject to the usual sanctions imposed by the pensions regulator, including the potential for a fine.
Further changes included in the regulations introduce a ban on active member discounts and the requirement for schemes to produce an annual governance statement. These changes do not come into force until 6 April 2016 and will be the subject of a later update.
A default arrangement is defined in the regulations as one used by a relevant scheme in relation to one or more jobholders and satisfies one or more of the following descriptions:
- An arrangement under which contributions of one or more workers are allocated to a fund or funds where those workers have not expressed a choice as to where contributions are allocated. This is the typical default arrangement.
- Where a worker is auto enrolled into a workplace pension scheme, it is done on the basis that members will not be required to make any active decisions to join the pension scheme. One key aspect of the auto enrolment process is where an auto-enrolled worker's pension contributions are invested. Members who do go into the default arrangement are of course able to decide alternative investment choices but it is likely that many individuals, once auto enrolled, simply remain in the default arrangement.
It is also likely that the definition of default arrangement will also cover funds which have been substituted by trustees or pension providers as part of a mapping exercise - whether because a fund is underperforming or because a transfer from one provider to another has taken place.
Default arrangements will also include arrangements already in place on 6 April 2015 (or the employer's staging date if that comes after 6 April 2015) and arrangements where contributions were first received after that date. In both cases, the investment vehicle will be treated as a default arrangement where 80% or more workers who were contributing members were allocated to that arrangement, even where the member was required to make a choice. This has been described by some as covering the "herd" option. AVCs are excluded from the 80% test.
The charging cap is 0.75% annually of the value of the member's rights under the default arrangement, or an equivalent combination charge. The limit in the case of the combination charge structure is 2.5% of the contributions allocated under the default arrangement annually and in relation to an existing rights charge, the percentage of the value of the member's rights corresponding to the contribution percentage charge rate.
The legislation is still in draft but it is unlikely that any significant changes will be introduced.
Trustees of money purchase schemes should ensure that any default arrangements under their scheme fall within the cap. There are a number of providers going through reorganisation process at the moment to enable schemes used for auto enrolment to comply with the requirements.
There is a process that pension scheme trustees can follow if they are unable to ensure that the default fund complies with the charging cap. The following conditions must be met:
- The trustees or managers of the schemes use their best endeavours to comply with charging limits in relation to one or more members of the default arrangement but have concluded that they are unlikely to be able to comply with those limits; or
- An event happens outside of the control of the trustees or managers and the trustees or managers have used their best endeavours to mitigate the effect of that event but have determined that because of the event in question, they are unlikely to be able to comply with charge limits.
The following conditions must then be met:
- the trustees or managers have elected to implement an adjustment measure in relation to the default arrangement
- the trustees or managers have informed the employers whose workers are members of the default arrangement, members of the default arrangement whose contributions have been allocated to that arrangement in the previous 12 month period and the Regulator of the following
- that the trustees or managers have determined that they are unlikely to be able to comply with the charging measures, the adjustment measure that would be provided and that the charge limits will no longer apply to members of the default arrangement on or after the adjustment date
The steps required to be taken as adjustment measures mean a measure where the trustees or managers will no longer allocate future contributions of members of the scheme to the default arrangement and will instead allocate future contributions to another default arrangement or where the trustees or managers will no longer accept future contributions of the members of the default arrangement into the scheme and will not allocate the contributions of any other members of the scheme into the default arrangement.
Trustees or managers can, however, decide to give affected members the option to agree to continue to have their future contributions allocated to the default arrangement.
The regulations do not apply to contract-based schemes such as group personal pension schemes. However, the FCA will be introducing rules which are largely aligned with the regulations. The Personal Pension Schemes (Restriction on Charges) Instrument 2015 will contain the following restrictions for personal pension schemes and GPPs:
- a cap on charges in default funds equivalent to 0.75%
- ban on firms paying or receiving consultancy charges
- a ban on firms paying commission or charges for services that are not initiated by scheme members from 6 April 2016
- a ban on active member discounts from 6 April 2016.
As the new flexible defined contribution regime unfolds, the focus on charging and ensuring good outcomes for members will no doubt continue.
This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.