Red tape risks
trapping savers in low return pensions

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Tens of thousands of pension savers across dozens of pension schemes could be trapped in unsuitable and low returning investments and in funds they never asked to be invested in because of pensions red tape, according to consultants LCP.

Under current rules, members of workplace pension schemes who are covered by the automatic enrolment rules are protected from high charges by the charge cap of 0.75% per year. This cap applies to the ‘default fund’, which is the fund into which contributions are directed if the member has not made any active choice about investments.

However, some workplace members may have actively chosen to invest some or all of their pot in property funds in search of higher returns. Unfortunately, as a result of the current coronavirus crisis, these property funds have been badly hit and most have been ‘gated’ – essentially closed on a temporary basis – because of the difficulty in valuing property assets in the current crisis.

In response, new contributions are being diverted, generally into low-risk, low-return cash investments as a short-term measure. However, according LCP, there is a risk that money may continue to flow into these low-return funds even once the crisis is past.

The issue is that when property funds re-open, the schemes will have to make a decision about what to do with future contributions if the member expresses no active preference. If the scheme decides that the member ‘would have wanted’ the money to go into the property fund, and they start to redirect new contributions into property, there is a legal risk that this could also be treated as a ‘default fund’ – as this now becomes another fund into which new contributions are directed without further action by the member.

The problem with this is that property funds typically have much higher charges (because of the costs associated with the investment) and could be in breach of the 0.75% charge cap. To avoid this risk, it is understood that some schemes are considering simply leaving member money going into low-risk, but low-return cash funds for the long-term, leaving it to members to make their own decisions. This could seriously damage the long-term prospects of savers, especially younger members who have a long time to retirement.

LCP Partner and head of DC, Laura Myers, is calling on the government to clarify the rules so that members do not suffer in the long-run.

Laura Myers said:

‘Where members have actively chosen to invest in property, they have been willing to face higher charges in the hope of securing better returns. It would be perverse if this was now regarded as a default arrangement and further, in breach of the charge cap. It would be even more perverse if the result was that member funds continue to be invested in an overly cautious way, which is likely to produce a lower pension pot at retirement. TPR’s guidance on this does not go far enough and leaves the issue open to legal interpretation and unfortunately worse outcomes for members. We urgently need clarity from government and the Pensions Regulator so that members do not lose out’.