On the starting blocks
Kalpana Fitzpatrick assesses industry reforms to the UK’s fledgling National Employment Savings Trust
The UK government’s new flagship pension scheme, the National Employment Savings Trust (NEST), will finally be launched this year, for the first time auto-enrolling millions of workers into a retirement fund in a bid to expand private pension coverage.
However, NEST has already been subject to criticism, with some industry experts arguing that it will be an administrative nightmare and will not achieve its objectives.
The scheme has already come under fire over its investment strategy, charge structure and low level of contributions. Members of NEST will have to make a minimum contribution of 8% of their salaries - 3% of which will be employer contributions and 1% tax relief.
Mark Futcher, associate at consulting firm Barnett Waddingham, argues that the low level of contribution rate sends out the message that 8% is enough for a decent pension - which is wrong. “It is not enough for a comfortable retirement. People need to save a lot more,” he says.
Robin Ellison, head of strategic development for pensions at law firm Pinsent Masons, argues that with such a low level of contribution, members should not expect exciting returns.
“The question is, will they be better off saving for a small pension or paying off debts.”
Ellison says that if NEST becomes too big, it would be hard to find a suitable investment strategy, especially if contributions were to reach 12%.
With vast amounts of money expected to flow into NEST, fund managers will face a number of challenges in maximising returns. Ellison says: “Investment managers are going to have to deal with larger amounts of money and they should be able to take higher risk for higher returns. However, with the tiny fees NEST will pay, it will be difficult for them to do anything exciting.”
But with the potential for NEST to become one of the world’s largest pension funds, fund managers are excited at the prospect of winning NEST mandates.
NEST has already put out to tender five mandates: global equities, UK fixed interest, index-linked gilts, cash, and a diversified beta fund. It says the five funds will serve as the underlying element for a range of target date funds, forming the default offering. They will be passive funds to start with, but that will change as NEST develops.
A spokeswoman at NEST said that these were initial mandates and others would follow. She stressed that NEST would not follow a low-risk strategy and that it would take appropriate risk where necessary.
NEST has already said it will not invest in high-risk alternatives such as hedge funds, infrastructure, commodities and high yields in the first few years.
Commenting on NEST’s investment approach, Futcher says the majority of members will go into the default fund, so NEST should ensure that the default funds actually deliver and are not simply in place for administrative purposes.
He adds: “Too much choice can also be confusing to members and a small range of funds is better.”
Concerns have been expressed that people will be put off by the initial 1.8% contribution charge as well as a 0.3% annual management charge (AMC). Futcher says the upfront charge could give out a negative impression, as a member’s investment would be reduced immediately.
“I think a 0.5-0.6% AMC would have been fairer; upfront fees are not fair, especially as NEST is trying to drum into people the importance of saving for retirement,” he claims.
Ros Altmann, director-general of the Saga Group and a former government adviser, adds: “I think that the 1.8% charge is too high - it means short-stayers will potentially be better off in a different type of pension scheme as they will not have time to benefit from the AMC. People in their fifties, for example, will be hit by this high initial charge.”
A spokeswoman for NEST says that the charges are “undoubtedly low” and would not
put people off.
“For many types of NEST saver, over their saving lifetime, that will work out as broadly equivalent to 0.5% AMC. Currently, NEST’s target market would not have access to this type of low charge and would instead be more likely to pay charges set around the stakeholder cap.”
Referring to a graph in a NEST briefing paper on the effects of charges on individuals, the spokeswoman says that “almost every type of saver pays less in NEST”.
Levelling down continues to be major risk, and there are serious concerns that NEST will make UK pensions provision worse, as employers look to level down their contributions similar to NEST.
Altmann says: “I fear that the introduction of NEST could indeed make pension provision worse, rather than better, because of levelling down. Employers who are currently contributing to pension scheme on a defined contribution basis are putting in, on average, around 6% of salary and they are bound to be tempted to cut back to the new lower ‘official’ 3% rate. This will not necessarily happen on day one, but the trend has already started, so I fear that NEST has already done some damage.”
She says that NEST is bound to increase pension coverage. “However, that is not necessarily the most important measure of success. Politicians and the industry are worried about the number of people putting money in to pensions, but what matters is whether they will have enough to give a decent income when they retire. Having more and more people with tiny pension amounts from NEST will not mean it is a success,” she adds.
Regardless of levelling down, industry experts have welcomed auto-enrolment with open arms, explaining that for the first time it forces people to save for retirement. However, some say it is vital that NEST does not promise too much.
“I think auto-enrolment is sensible but I would have preferred to have seen it without any minimum pension contribution figure and with enrolment into private sector schemes, not a nationally organised scheme,” says Altmann.
“There is significant risk for future governments in that workers will be lulled into a false sense of security by NEST and then find it delivers very little. I think we should be getting people to save, but not necessarily in just a pension.”
There is also a danger that people will opt out after being auto-enrolled, and if too many people do opt out, NEST could become an administrative nightmare.
Altmann argues: “I have always warned of the administrative nightmare of NEST. The risks are enormous. We know that government makes mistakes and computer systems are liable to error. With the complexity of pensions and the tiny pots of money that will need to be tracked for decades the outlook is worrying.”
NEST has appointed Tata Consultancy Services (TCS) to administer the scheme, but the fact that TCS was the only firm to tender for the contract has raised concerns.
“There are concerns about the scale and size of the project and it is worrying that no one else went for the contract,” says Futcher.
Ellison adds: “NEST could become massive and they will need a robust computer system in place, so let’s hope it works.”
NEST says it is confident that TCS will deliver a “great service” to its members.