During Wednesday’s Autumn Budget, the chancellor may have spent more time talking about bubbly than pensions - but he did declare his intention to press ahead with a review of the default charge cap. The Treasury is also offering a half-hearted solution to the ‘net pay anomaly’.

 

The Budget has been criticised for being more about prosecco than pensions, with chancellor Rishi Sunak talking in detail about the planned simplification of alcohol duty. Pensions got a cursory mention in the speech – as part of announcements on supporting venture capital.

 

Similarly, Budget documents make no distinction between supporting new ventures and pension investment, seamlessly moving from one to the other. The government said that it will consult “on further changes to the regulatory charge cap for defined contribution auto-enrolment pension schemes to enable pension savers to benefit from better growth in their long-term investments” before the end of the year. 

“The consultation will specifically consider amendments to the scope of the cap to better accommodate well-designed performance fees and enable investments into the UK’s most productive assets, while continuing to protect savers,” it added. 

 

The renewed attempt to change the cap of 0.75% that applies to charges for default options in defined contribution funds had been well trailed, and the industry seems to be open in principle to allocating assets to illiquids, amid greater volatility in equities and record low interest rates.

However, investment consulting firm LCP said in discussions about investing in illiquids, it has seen much greater focus on other concerns than the charge cap among its clients, such as a focus on low charges, which are already well below the charge cap, how and how frequently to value illiquids to make the allocation fair for all members, transparency of fees and a lack of guidance from regulators. 

 

LCP’s head of DC, Laura Myers, said while the impulse comes from the right place, a plan to scrap the charge cap misses the point. “There are a whole host of other concerns leading to industry reticence to invest in these assets, not least around issues regarding fairness for members and the opaque nature of illiquid assets,” she said. 

 

“There is also the reality that many DC schemes invest via insurers who don't accept many illiquid assets so this won't be changed by the magic bullet of charge cap changes. It's a missed opportunity to address perceived barriers and some industry nervousness,” she noted. 

  

DC investors seem to agree, saying changing the cap won’t in and of itself change how DC schemes invest. Phil Brown, director of policy at B&CE, which provides master trust the People’s Pension, said if the government wants pension schemes to invest in a broader range of asset classes to help deliver its ‘levelling up’ agenda, it must first challenge the investment industry on the current cost of these, ensuring they are “fair and reasonable and provide value for money for the saver”. 

  

Brown said: “By itself, changing the charge cap isn’t going to make schemes invest differently – a package of measures is needed – and any change to the cap must maintain an equivalent level of member protection in order to prevent a return to the problems of the past.” 

 

Plans to increase the charge cap may be great news for asset managers but will dilute long-term returns and may not even be necessary, said former pensions minister Baroness Ros Altmann. 

 

The majority of workplace pensions charge less than 0.75% cap, she pointed out, with some investing in illiquids below the cap. “Fund managers understandably wish to charge more to manage long-term illiquid projects as the costs of overseeing and managing such investments can be higher than for mainstream market investing. However, it is not clear that the charge cap has been the main factor deterring pension funds from supporting infrastructure, housing, private equity and other potentially higher long-term return investments,” said Altmann. She blames daily pricing and the quick transferability of workplace pension schemes if members wish to take their money out. “Increasing the charge cap does nothing to resolve those problems,” she said. 

 

Instead, defined benefit schemes, which hold more than £2tn of assets, should be encouraged to invest in illiquids, she said. “Currently, those DB schemes are deterred from alternative and illiquid long-term investments because of regulatory pressure to ‘reduce risk’,” she said, adding: “Driving funds into supposedly lower risk assets also means lower returns, which places extra burdens on employers and does not utilise the assets optimally for growth-boosting projects.” 

 

The Pensions and Lifetime Savings Association said the charge cap is currently set at the correct level, noting that in practice, most schemes operate below the cap anyway. 

"Measures to amend the charge cap, particularly related to the smoothing of performance fees, might make it a little easier for some schemes to invest in illiquid assets. However, we do not believe that alterations will necessarily lead to a material change in investment in illiquid assets,” said director of policy and advocacy, Nigel Peaple.  

 

Pointing to the changes to the charge cap which came into force earlier this month, relating to performance fees, he said: “We would rather the government allowed some time to see what effect these recent changes have before consulting on further amendments.”  

 

Peaple added that the pensions industry is very open to investing in illiquid assets if they match the needs of scheme members, “but this is a complex area, and we do not think the current charge cap is blocking such investments”. 

 

Other lobby groups are however seeing potential benefits in further changes to the cap. The Association of British Insurers, which represents group personal pension providers, has welcomed a review. Yvonne Braun, director of long-term savings and protection policy, said: “UK pension savers should be able to benefit from the greater return potential of investing in illiquid assets, such as infrastructure and renewable energy projects.” 

 

The Investing and Saving Alliance, is equally in favour of reviewing the DC charge cap. However, Renny Biggins, head of retirement at TISA, added: “It will be interesting to see how this fits in with the new [Pensions Regulator] and [Financial Conduct Authority’s] discussion paper on value for money, which considers more disclosure around net performance and risk, costs and charges.” 

 

 

The government has, following years of campaigning, also agreed to facilitate the claiming of tax relief top-ups for those in net pay schemes who are earning between £10,000 and £12,570, meaning they are auto-enrolled but earn below the income tax threshold. While savers in relief at source schemes will automatically receive a top-up even if they do not pay tax, this is not the case in net pay schemes. 

 

Responding to last year's call for evidence on this so-called ‘net pay anomaly’, John Glen, economic secretary to the Treasury, said the Treasury has identified a solution to broadly equalise outcomes for all lower earning pension savers. 

 

He said that “individuals making pension contributions to net pay schemes from 2024-25 will be eligible to claim a top-up. Up to 1.2 million individuals, 75% of whom are women, could benefit by an average of £53 a year. As a result of this change, all lower earning pension savers should receive similar outcomes, regardless of how their pension scheme is being administered for tax purposes.” 

 

The government will introduce “a system to make top-up payments directly to low-earning individuals saving in pension schemes using a net pay arrangement from 2024-25 onwards”, the Treasury states, though it avoids the word ‘automatic’. 

 

Payments will be made after the end of each relevant tax year, meaning the first ones will only be paid out in 2025-26. This would potentially coincide with reforms due in the ‘mid-2020s’ that will extend the scope of auto-enrolment.  

 

 

In the two tax years from 2025 to 2027, the Treasury expects to pay out £25bn on tax relief, which would flow into pension schemes and their investments. The fact the government has budgeted £15bn a year implies that less than a quarter of the available top-ups are expected to be claimed, said David Robbins, director at consultancy Willis Towers Watson. “Putting the onus on individuals to claim a top-up inevitably means that many won’t,” he noted. 

 

Sir Steve Webb, a former pensions minister and Liberal Democrat MP in the coalition government, now a partner at LCP, said the government’s tax relief solution for the low-paid is “messy, belated and likely to be ineffective”. 

 

While the action is welcome, he warned that if the solution is dependent on workers claiming the top-up, it risks significant non-takeup. “This is yet another sticking plaster response to a problem with the pension tax relief system which needs a systematic overhaul,” he said. 

 

Workers having to jump through tax hoops to receive modest compensation because they happen to be in one pension system rather than another could be seen as an unfair disadvantage in the tax system, suggested Ian Neale, founder of policy experts Aries Insight. “Payments should be made automatically,” he said. 

 

He noted that the delay until 2025 for payments to be made was attributed to significant IT system changes. “If that is true, might HMRC finally acknowledge that it is unfair to expect the private sector to make similar changes with any less advance notice?” he said. 

 

The fact that the fix will not be back-dated has also been criticised by some in the industry. Mike Smedley, partner at consulting firm Isio, found the announcements on Wednesday wanting. 

 

“This is a budget of inconsistencies. Make domestic flights cheaper whilst we try to reduce air emissions. Cut alcohol tax whilst ploughing more money into the NHS. And with pensions, whilst the government is finally creating a level playing field for lower earners on pensions tax relief – with the new Net Pay top-up arrangement – this won’t come into effect until 2024 and won’t be backdated,” he said.  

 

Smedley highlighted that the government announced it will make the remedy for public sector workers, due as part of the McCloud age discrimination case, tax exempt. This means the Treasury will be foregoing hundreds of millions of tax income. 

 

“We’ve had over a decade of low earners being penalised for being in the ‘wrong’ type of pension scheme, and the Budget shows costs the cost of fixing the anomaly is £15m each year. Meanwhile the government has decided to waive £500m of tax each year from those public sector workers who will get pension windfalls from the McCloud judgment,” he said. 

 

 

Ian Neale

Nigel Peaple

Mike Smedley

Rob Yuille

 

Ros Altmann

Laura Myers

Tim Gosling