The recent pension freedoms have thrown into question the suitability of default funds, which were designed on the assumption that members would purchase an annuity at the point of retirement.              

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An annuity is now just one option alongside income drawdown and cash withdrawal. Together with the implications of the charge cap, and the ongoing challenge of engaging members in investment decision making, default fund design is once again in the spotlight.

The charge cap – catalyst for change or “blunt tool”?

For the very many defined contribution (DC) members who do not actively choose a fund in which to invest their workplace savings, and will be put into the scheme’s default fund, value for money is a critical factor. Schemes clearly need to work effectively for members and according to the Financial Conduct Authority (FCA), the charge cap, alongside other new measures, will help to ensure that this is the case.

The Department for Work and Pensions (DWP) has reported that:

“Small differences in charges can have a major impact on a pension pot by the time a person retires. An average earner due to accumulate a pension pot of around £30,000 could benefit to the tune of £1,600 by saving in a scheme charging 0.75% compared to one which charges 1.5% – and for many the boost could run into tens of thousands of pounds.” [1]

But the National Association of Pension Funds (NAPF) has described the cap as a “blunt tool”, at a time when competition is already driving charges down below the 0.75% level[2].

Lesley Williams, Group Pensions Director at Whitbread, comments: “We knew we were going to have to make some changes to our DC arrangement when the charge cap was introduced. My trustees had spent several years working out how to achieve a diversified investment strategy for DC members at a cost they would be happy with. They made some relatively brave decisions but that’s what they needed to do. So we have had to unpick some of the work we did earlier, which is not where we wanted to be.” Despite being well-intentioned, in some cases the charge cap has forced an unwelcome change of strategy.

This article is an extract, based on a panel discussion which took place during a Pensions Intelligence Seminar on 11 May 2015.

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