Auto Enrolment is the name most often used in relation to the compulsory pension funding initiative which is currently being rolled out in the UK, whereby most employees and their employers will be compelled to make pension contributions unless they individually decide to opt out.
This is the current initiative to encourage people to save for their retirement and the concern about charges has been raised again recently as the concern is that the returns for individuals will be adversely affected by administration charges that are too high.
In 2001 we saw the Labour Government introduce Stakeholder pensions that had initially an annual charge capped at 1% to ensure that charges were kept to a reasonable level. The pension industry at the time was majorly concerned that they could not survive on such low charges and this led to further consolidation of the number of providers.
It was recognised that survival as a pension provider was going to be a case of survival of the fittest and that volume business would be required to enable the companies to remain profitable.
As the 1% annual charge is levied on the value of the pension fund rather than the contributions being paid, over time, the charges become large numbers.
For example, if you start saving ¬£1,000 a year into a pension fund, the charge will be ¬£10 in the first year; that does not seem too bad as an investor. From the pension provider¬ís perspective, most of their costs are at outset and they will make a loss initially, but before you feel too sorry for them, let¬ís just roll the clock forwards a few years. That ¬£1,000 a year, with some investment growth over say a 30 year period could see a pension fund value of ¬£83,766 assuming a 6% annual growth rate and 1% of that amounts to ¬£837.66 ¬Ė not such a small sum and it actually can appear a lot worse!
If that 1% had not been charged each year, the investment would have grown in this example to around ¬£114,183; that is a difference of ¬£30,417 over the period and this is the concern that is being raised now about pension fund charges.
You could say that this is a strong case for paying the cost of administration separately from the investment itself but who wants to get an invoice from the pension provider every time you make a contribution?
The other way to look at it though is that without the savings, you would be ¬£83,766 worse off because you would have spent your ¬£1,000 a year on other things and in all probability would have nothing to show for it!
Oh, and by the way, the ¬£30,000 you saved only cost you ¬£24,000 anyway because of the tax relief you received along the way ¬Ė always assuming that tax relief applies throughout at the current rate of course.