Traditional pension schemes get bad press, and for good reason, as the charges on older-style schemes can be extortionate.
Some of the worst legacy pension schemes charge 4% in annual management fees alone, while the majority make charges of around 2% or more.
The impact of compounding over the years on even a small charge is massive. For example, if you can reduce your charges by just 1.4% a year, your pension pot will be more than 42% better off after 25 years.
Investors with modern pension schemes have little to worry about, however, as charges have been steadily reducing for two decades. The Association of British Insurers (ABI) says the average modern scheme has charges of just 0.52%, which is significantly cheaper than an individual savings account.
Crackdown on poor value
Pension companies aim for consistency
A group of ABI members are working together to provide consistent disclosure of pension charges in workplace schemes.
The agreement will be implemented by next summer for schemes newly established for auto-enrolment, and by 31 December 2015 for all older workplace pension schemes.
A common definition of all charges in sterling terms (including any entry or exit charges) will be disclosed at the outset to members, and also the total charges taken in the previous year, including transaction costs.
Providers that have signed up to this agreement are: Aegon, Aviva, Axa, B&CE (The People's Pension), Co-operative Insurance, Friends Life, Legal & General, Lloyds Banking Group,
=, MetLife, Prudential,
Royal London/Scottish Life, Standard Life and Zurich Assurance. LV
The Office of Fair Trading (OFT), which has recently finished a six-month study into pensions, is cracking down on poor-value arrangements through a series of reforms. The watchdog has identified two areas where the risk of rip-off is greatest - both relate only to defined contribution pension schemes, not final salary schemes.
The first involves "legacy" schemes. This term is commonly used for any contract-based scheme set up before 2001 (which might, for example, be a group personal pension); and the second covers smaller, trust-based plans with fewer than 1,000 members.
The OFT has ordered pension providers to undertake an audit of all such schemes, and also all post-2001 schemes with a charge of 1% or more.
By the end of 2014, savers in many of these schemes should start to enjoy a better deal, as their providers will be forced to reduce their charges.
However, the OFT stopped short of recommending a specific cap on charges in defined contribution pensions, saying that the position is simply too complicated, as schemes set up years ago impose a baffling array of regular and one-off charges, including opaque structures such as reduced allocation rates.
These charges are levied in different ways over various timescales for each individual saver, and are even set out in different documents - making it almost impossible for investors to calculate the total amount.
But these complexities have not dissuaded minister for pensions Steve Webb, who says the government will press ahead with a consultation on a possible charges cap.
The charges in legacy schemes are hard to quantify at scheme level, because they are not single-charge schemes, unlike most modern schemes, says John Lawson, head of policy at Aviva.
"They are multi-charge schemes with bid/offer spreads, initial unit charges, monthly policy fees, low allocation periods and the like. You can really only reliably examine charges in these schemes at individual member level, using reductions in yield (RIY), which is the equivalent of an annual management charge (AMC) in the modern world.
"For example, the National Employment Savings Trust (NEST) pension is a multi-charge scheme, and its RIY charges vary from more than 1% for someone within five years of retirement to 0.5% or less for someone with 18 or more years to retirement. The RIY at individual member level for some old schemes could well be more than 2%," he added.
Some insurance companies, such as Aviva, are already taking steps to improve their plans by capping legacy charges in group personal pensions set up before 2001.
Although the multi-charges are likely to remain in place, the insurer can calculate the charge on a monthly basis; if the RIY exceeds a certain level (1% in Aviva's case), it may add extra units to bring the charge down to that level.
The magic number quoted by politicians as a suitable benchmark charge has historically been 0.5%, but in recent months Webb has shifted to talking about a potential 0.75% cap on management fees.
The Department for Work & Pensions (DWP) is consulting on a range of options to make fees more transparent and easy to compare, including the disclosure of a single AMC plus transaction costs, and capping the investment management charges for default funds in schemes used for auto-enrolment.
Employers in a quandary
The OFT investigation also found that employers, who after all are responsible for deciding which pension scheme to choose for their employees, not only lack the capability to assess value for money but also lack an incentive, since most employees are apathetic about the concept of pensions and can't penetrate the jargon.
This will be exacerbated over the next few years, as smaller employers with limited resources put auto-enrolment schemes in place.
The OFT's stance is supported by the findings of a recent survey by consultancy Secondsight, which found that two thirds of employers had little or no knowledge of auto-enrolment legislation, a third plan to comply without external help, and more than a quarter think they will be able to spend less than one day in complying with the regulations.
Most legacy schemes also impose exit fees, which range from 3 to 20% of the fund, preventing savers from moving to better-value plans. This particularly impacts on people with a fragmented career history, typically women.
Many schemes also operate "active member discounts", where an active member is charged a smaller AMC than former employees who have subsequently left the organisation. The difference may be around 0.3-0.5% on the AMC. The practice will be outlawed in future, starting with schemes used for auto-enrolment.
The government is currently working on a pot-follows-member scheme to improve the portability of pension funds from one employer to another, and early-leaver penalties will be a central consideration.
While legacy schemes are contract-based schemes, so-called because the member has a direct contract with the life insurer, trust-based schemes are very different and fall under the auspices of The Pensions Regulator (TPR), rather than the Financial Conduct Authority.
Many modern, large trust-based schemes, especially those that cover a whole industry, have attractions such as economies of scale and improved governance.
However, some off-the-shelf trust-based schemes carry traditional insurance company-style charges, and historically were chosen by employers largely because until quite recently they allowed the sponsor to recoup the first two years of any premiums paid when a staff member left during that period.
The worst are generally "bundled" schemes where the administration is also run by the plan provider. TPR is taking steps to assess which smaller trust-based schemes are not delivering value for money, and the DWP is considering whether the regulator needs new enforcement powers to tackle the problem.
The OFT also highlighted other features of these trust-based plans that are not what they are cracked up to be, in particular where master trust boards are not sufficiently independent from their parent company; so although they appoint independent trustees, it is just a veneer of impartiality over an underlying commercial bias.
Independent governance committees should be able to switch the default fund or administrator to another service provider if that is in the members' best interests, says Aviva's Lawson. He also argues that TPR needs to beef up its powers.
"A regulator that needs to plead with those under its jurisdiction to "comply or explain" is not a regulator; it is a standards body," he says.
The OFT has ordered schemes to appoint independent governance committees by the end of 2014, with the power to recommend changes and escalate issues to regulators where necessary.
In the future these will be the people to approach if you have a bone to pick about your scheme's investment offerings or structure. The committees will oversee value for money on an ongoing basis, as well as ensuring any action recommended following the legacy reviews is carried out.
"Some providers of personal pensions and packaged master trusts will find this review challenging," says Lawson.
"The audit will also take into account other aspects of VFM [value for money] such as investment performance and service standards."
The DWP is also preventing schemes being used for auto-enrolment if they contain in-built adviser commissions, and is considering whether to extend the ban on pension scheme consultancy charges to historical arrangements that pre-date its implementation in May 2013.
One conundrum is that NEST, although relatively expensive, is the de facto government scheme.
Former Treasury adviser Ros Altmann says: "This government-sponsored scheme charges 1.8% of every worker's contribution and an ongoing annual charge of 0.3%. The Treasury insisted on a high up-front charge to try to recoup the taxpayer loan to NEST - which had to be ratified by the European Union - as quickly as possible."
How ironic that this level of fees is deemed acceptable for a government-borne scheme, but not for any other.