1. What is the background to the charge capping measures?
In April 2014, the DWP published “Better workplace pensions: Further measures for savers”. The April command paper set out the Government’s proposed scheme governance measures which were intended both to complement the Budget 2014 pension flexibilities and to bolster the implementation of auto-enrolment. The April command paper included consultation questions on the governance standards in all defined contribution (DC) schemes and the charging structures in DC schemes which were used for auto-enrolment (Qualifying Schemes).
On 17 October 2014, the DWP published its follow-up command paper entitled “Better workplace pensions: Putting savers’ interests first”. The October command paper provides a response to the March 2014 consultation on quality standards and charges in DC schemes, and includes draft regulations proposing to bring into force the following changes on 6 April 2015:
- new minimum quality for standards for both contract and trust-based DC schemes;
- the introduction of Independent Governance Committees (IGCs) for contract-based schemes to assess compliance with quality standards;
- requirements for greater transparency of costs and charges in all DC schemes, with IGCs and trustees being required to disclose such information in standardised form; and
- a charge cap of 0.75 per cent on funds under management (excluding transaction costs) in the default funds of Qualifying Schemes.
This briefing focuses on the last point above – that is, the charge cap for default arrangements in Qualifying Schemes. This measure is intended to protect people who have not made an active investment decision in respect of their pension savings from higher fund charges.
2. Why are these measures being introduced?
With auto-enrolment now in place for all but the smallest employers, the Government is keen to ensure that members who are automatically enrolled in membership of a pension scheme are protected from high charges in default funds. The charge cap will mean that the Government sets a maximum cost for auto-enrolment pensions.
3. What are the transaction costs which are to be excluded from the cap?
Transaction costs are defined as “the costs incurred as a result of the buying, selling, lending and borrowing of investments”. The costs attributable to pension sharing and complying with court orders, and costs incurred by trustees as a result of scheme wind-up are also expected to be excluded from the cap. At Annex B of the command paper, there is a non-exhaustive list of examples of costs and charges that the DWP would expect to be excluded from the scope of the default fund charge cap. However, the fact that the list is non-exhaustive could lead to some uncertainties.
4. When will the charge cap be implemented?
The intention is that the charge cap of 0.75 per cent (excluding transaction costs) for default funds in Qualifying Schemes will apply from the later of 6 April 2015 and the date from which the scheme begins to be used for auto-enrolment (the Relevant Date).
Consultancy charges will also be banned from this date, with the position being reviewed in 2017.
5. Will the charge cap continue to apply when a member stops contributing?
Yes. The charge cap will continue to apply for as long as the member’s funds remain invested in the default arrangement of a Qualifying Scheme, including where the individual becomes a deferred member and stops contributing. The cap will apply to all of the member’s funds in the default arrangement, irrespective of whether the contributions were made before or after the introduction of the cap.
The Government intends that any employee member of a Qualifying Scheme after 6 April 2016 must not be charged more when they cease contributing than they were as a contributing member. In the past, this practice, which is known as the active member discount (AMD) has meant that deferred members often experience higher management charges than active member investors in the same fund.
However, the ban on AMDs will not prevent employers subsidising or paying the member-borne deductions of active members. Where employers pay certain charges on behalf of current employees, this will be permitted to continue as long as the total of charges paid by active and deferred members is the same.
6. Do the charge gap and the ban on AMDs apply to all DC schemes?
No. Where a DC arrangement is not being used as a Qualifying Scheme, it will not be subject to the charge cap or the AMD ban.
7. What is a default fund?
The term “default arrangement” has been widely drafted and includes:
- any arrangement into which workers’ contributions are directed without them making an active choice;
- an arrangement into which 80 per cent of the employer’s workers are actively contributing on the Relevant Date. A one-off assessment is carried out at the Relevant Date, and there is no ongoing requirement to monitor the proportion of active members, although the proportion is likely to change over time; and
- an arrangement into which 80 per cent of the employer’s workers first made contributions after the Relevant Date. This will require trustees to monitor on an ongoing basis the proportions of members invested into the employer’s various funds to see whether any arrangement meets the default fund definition at any point.
It is possible that the definition could include more than one fund within a given scheme.
8. Will the charge gap have retrospective effect?
It depends. Although the 0.75 per cent cap on default fund charges will apply from the Relevant Date, it is possible that it could apply to a default arrangement that is already in existence at the Relevant Date. This is because the term “default arrangement” is drafted widely, and can also include funds into which many of the employer’s workers already contribute (see question 7).
9. Will all investors in a default fund pay the same charges?
Yes. The intention is that members of the same scheme in the same organisation enrolled in the same arrangement should all pay the same charges.
Where members’ contributions have been redirected to a new fund without them making any active choice, this fund will be considered a default arrangement. However, where a member has made a recent active choice to remain invested in a particular fund, despite an alternative cap-compliant fund being on offer, the fund in which he has chosen to remain invested is not classified as a default arrangement. If at any time in the three month period ending with the Relevant Date a charge cap-compliant default is offered to all the members who are actively contributing to such an arrangement, where a worker agrees in writing to remain in that arrangement (i.e. in the fund with higher charges than the cap) then it would not be subject to the cap.
The consultation paper provides detailed examples which clarify how these provisions apply in practice.
10. What action should trustees now take in relation to the charge cap?
Trustees should assess their current default fund offering to ensure it will comply with the charge cap from their scheme’s Relevant Date.
Where an existing default fund is not charge cap compliant, action will be needed to notify members where it is necessary to put in place a different fund as a default arrangement. However, where members have been asked if they wish to remain in an existing fund which is not charge cap compliant and they choose to remain invested in such a fund, that is permissible.
Trustees may need to seek advice in order to assess their default fund offerings and to ensure they will be charge cap compliant by the Relevant Date for their scheme.