DWP's consultation on capping exit charges in occupational schemes has closed. Despite agreement on removing barriers to the freedoms, Michael Klimes finds there will be major administration hurdles.
- Government is committed to introducing level playing field on charges
- It is harder to cap exit fees for trust-based schemes
- Responses to DWP consultation bear this out
The theme of exit charges has been prominent in the industry during the past two years. A line of thought has emerged which says people should not be penalised for accessing their pensions early.
The Department for Work and Pensions (DWP) wants to bring early exit charges in trust-based schemes into line with planned caps for personal schemes to remove any barriers to accessing the pension freedoms.
Its consultation on capping early exit charges for occupational pensions ended on 16 August. This mirrors the Financial Conduct Authority (FCA) which is consulting on banning early exit charges for new pension freedom contracts and cap existing ones at 1% of the value of the pot until 18 August.
Reponses to the DWP's consultation demonstrate the administrative challenges in implementing a cap in occupational schemes. The Society of Pension Professionals (SPP), the Pensions and Lifetime Savings Association (PLSA), Hargreaves Lansdown and Aquila Heywood all hit on the complexity in their responses. The main dilemma is schemes must find a way to administer a cap on exit charges sustainably.
Cap or blanket ban?
Hargreaves Lansdown favours a blanket ban on exit charges as he argues the 1% cap for existing pension contracts is too high. Head of retirement policy Tom McPhail says: "Exit penalties should be scrapped altogether. Product providers have to charge for their administration services but that doesn't justify penalising customers who want to move their money elsewhere. There's no reason for not extending the ban to all pension contracts, old and new."
However Aquila Heywood, a pensions administration software provider, says a 1% cap is reasonable with a maximum charge of £500 for transfers, which can require a lot of work and therefore cost more.
The firm warns treating members differently could store up problems for the future such as increasing regulatory arbitrage.
Furthermore, a cap that only applies to people aged over 55 could lead to younger savers subsidising older savers.
To mitigate this and include simplicity, Aquila Heywood proposes imposing just one cap and a "white list" of recommended schemes and administrators. In theory the list could speed up transfers and minimise costs.
Still, there are areas where such suggestions might not be effective. Hogan Lovells counsel Nicola Rondel, who is also chairwoman of the defined contribution (DC) committee at the SPP, points to a larger problem in occupational pensions.
"The questions [in the consultation] are very unclear and demonstrate occupational pensions have a tortuous and more opaque system in relation to personal contract-based schemes," she says.
"It is much harder to answer these questions in this context [on capping early exit charges] just because of the way schemes are set up, because it is a collective, not individual arrangement."
Two examples which illustrate the administrative difficulty of the cap are explored in the SPP's response.
In an unbundled trust-based scheme the application of an early exit charge is rare, but SPP's response noted "it could occur and it is important to have complete clarity".
Here the trustees decide if any exit charges must be applied but the factors to determine the cap are tricky to negotiate. These include the size of the cap (1% or a complete ban), whether it applies to existing or new members, the type of contract and start date from when the cap applies.
For instance, the start date could be when the trustees entered into a contract with a third-party administrator, so any existing members would be subject to a 1% cap.
Alternatively the cap could be applied to when members joined the scheme but "there needs to be clarity" on what funds the cap would apply to, say the SPP.
The other technicality applies to any members aged 55 and over who exercise their freedoms. If a scheme has members in that bracket who transfer without using their freedoms and those who do, the cap will apply to the latter.
Therefore trustees will have to spend more time on deciding which members the cap applies to, which is yet another administrative challenge.
Both these difficulties demonstrate the problem with trust-based administration where "it is more of an overarching contract which applies to all members regardless of how long they have been in the scheme", Rondel continues.
The SPP said it expects the 1% cap will apply in respect of existing scheme members, and a complete ban for new members.
Clearly, the SPP's questions need answers. The PLSA echoes this, arguing the government will only succeed if it allows members to access benefits while simultaneously allowing schemes to recoup administrative costs in a fair manner for all members.
PLSA policy lead of DC Tim Gosling says: "We are pleased that the government's proposals to cap charges will protect savers while allowing schemes to recoup administrative costs in a way that is fair to the membership as a whole."
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