Personal pensions – once a staple for the majority of savers – face an uncertain future. The government’s continued overhaul of retirement rules and regulations has arguably deterred rather than invigorated savers.
Self-invested personal pensions (Sipps) have long been a preferred option, while the rise of auto-enrolment (AE) and cuts to the annual and lifetime allowances have added further complications. On top of this is the imminent launch of the Lifetime Isa (Lisa), a high-profile product that will give younger consumers one more reason not to look at personal pensions. But these schemes are not dead yet, and nor is the rationale for utilising them.
Fiona Tait, pensions specialist at Royal London, does not believe the market is set for a further decline. “For many workers, AE may be the conduit to their first pension plan, most likely via a group personal pension. [And] personal pensions will continue to be suitable for those who do not qualify for AE or wish to augment their workplace savings with an individual plan of their own,” Ms Tait explains.
Personal pensions were very much the lifeblood of the retirement savings industry in the early 1990s, especially for sole traders and small businesses. With the private sector beginning to gradually phase out final-salary schemes in the belief that their costs were unsustainable, the switch from defined benefit to defined contribution plans meant many more providers could manage a company’s full pension arrangements rather than just additional voluntary contributions.
The majority of group pension arrangements were individual plans purely set up through an employer. Upon leaving the firm, the plan would transfer into the employee’s name and personal contributions could continue. However, the process has been complicated by AE. The eventual arrival of the pensions dashboard hopes to mitigate the problem of consumers accruing a large number of small pots.
In the short term, the most significant barrier to interest in personal pensions may stem from a different source. The Lisa’s potential to harm AE has been widely discussed, but it is perhaps personal pensions that will suffer most, given that the Lisa bonus broadly reflects the basic rate tax benefits of a pension.
David Thurlow, director at wealth management firm Mattioli Woods, feels the Lisa will provide direct competition for personal pensions. “We know the government has been looking at ways in which it can move the pension system away from where it is at the moment. It strikes me this is a gentle move in this direction.”
As always, our annual survey seeks to identify any recent trends in the personal pension market and delve into the performance and make-up of the underlying investments. The number of respondents is lower than last year, which could provide an indication of a dwindling marketplace.
Regular contributions
For early personal pensions such as retirement annuity contracts, with-profits represented the sole investment approach. These plans have the potential for bonuses to be applied and guaranteed a minimum fund or specified annuity rate depending on the date of inception.
Table 2 shows the open market options for with-profits policies maturing on 1 January 2017 following £200 per month contributions over five, 10, 15 and 20 years. Performance data for firms that declined to complete the survey is taken from latest F59 figures to 1 March 2016. Several firms do not have short-term figures available as they no longer have open products in the space.
The results show little difference from last year in aggregate. Despite the changing number of respondents, averages for the 20-year period remain the same at 5 per cent growth per annum.
Figures for 15-year periods have improved – the average growth rate has risen from 5.1 per cent to 5.6 per cent – but five-year averages have fallen from 6.7 per cent to 6.3 per cent. Stockmarkets fared well during 2016 despite a number of surprise events, but with-profits funds are less responsive to short-term moves due to the application of smoothed bonuses.
Regardless, some funds stand out from the crowd. When assessing performance over a five-year period, LV delivered the strongest results with average growth of 9.4 per cent per annum. With-profits funds have drawn harsh criticism in recent years, largely centred on the fact their investment strategy is outdated and opaque. However, achieving above 9 per cent per annum in a low interest environment is a decent counter-argument.
LV policy head Philip Brown said teaming up with Colombia Threadneedle has been fundamental for this success. “This partnership has meant our main with-profits fund has been able to beat market benchmarks over significant periods,” Mr Brown says.
Other respondents have been unable to deliver the same success. Notably, the Scottish Widows fund only returned 3.6 per cent over the five-year period, with a terminal bonus of only £372 (2.8 per cent of the fund) clearly affecting investors.
Figures improve over longer investment periods, with average growth of 4.3 per cent and a terminal bonus of just under 20 per cent over 20 years. With investment returns predicted to be more subdued over the coming 12 months, with-profits managers are likely to face a testing time, even with the potential to smooth returns.
Lump sum
The analysis of with-profits continues in Table 3, this time focusing on a standalone lump sum of £10k. Like-for-like, those who made a lump sum contribution have fared slightly worse than those who contributed monthly. Figures have worsened more notably since last year’s survey, too: the 20-year average growth has fallen from 6.6 per cent to 5 per cent.
Providers’ differing approaches to bonus application is also evident from the tables. With-profits managers can add bonuses annually and at policy termination. Once annual bonuses are added they cannot be removed, whereas final bonuses can be adjusted – generally twice a year – to reflect market and economic conditions.
The other significant issue is that market value adjustments (MVAs) can be levied for those that wish to transfer out or take benefits before their selected retirement date.
The most definitive data highlighting these disparities is in the 20-year numbers. They show that a large terminal bonus is not necessarily indicative of impressive overall performance.
Pearl Assurance, which is now managed by Phoenix, is a case in point. Although it added a terminal bonus reflecting 36.8 per cent of the total value, the fund only returned an average of 4.4 per cent pa. In contrast, Royal London’s ex United Friendly plan added a final bonus of only 14.5 per cent, but managed to outstrip the Pearl over 20 years by averaging 5.4 per cent pa.
Generally, the most consistency was found in those plans providing a mixture of both bonus types, with Royal London Mutual’s unitised plan coupling a terminal bonus of more than 55 per cent with an average return of 6.5 per cent pa. However, Scottish Provident proved that this is clearly not the only recipe for success, as it delivered 7.6 per cent pa despite only applying annual bonuses. This highlights the importance of not reviewing bonus additions in isolation.
Sector standouts
In recent years, advisers and savers have sought out more flexible products as an alternative to with-profits. This has created a vast universe of investment funds to suit an individual investor’s needs and objectives. The performance of the main Investment Association sectors can be seen in Table 4.
They give not only an indication of performance, but also the levels of risk.
Global emerging markets have witnessed difficult times in recent years after soaring growth in that last decade. But the past 12 months have seen a return to form, meaning five-year average growth figures hold no cause for alarm. The inherent risk of emerging markets remains clear though. Based on a monthly contribution of £200 per month over a five-year period, the worst performing emerging markets fund – Royal London’s Threadneedle Latin American fund – would have grown to only £11,863, while the average deposit and treasury fund would have returned £11,835.
In terms of the best and most consistent sector, North American equity funds hog the limelight. Donald Trump’s presidential triumph has done little to quell thriving US markets, but with his term still in its early stages, it is unclear whether this can be sustained over the long term.
The average North America fund has exceeding 8 per cent average annual growth over the past two decades, based on £200 per month contributions, with this falling to 6.7 per cent on a £10k lump sum.
By contrast, cash returns could only muster 1.2 and 2.5 per cent over the same respective periods.
Some less risky sectors have thrived though. Index-linked gilts, benefitting from the bond bull market and quantitative easing, have delivered returns in excess of 7 per over the longest-measured period; far higher than other sectors mirroring their more stable nature and many equity funds.
Fund favourites
Table 1 lists the top five funds over the various periods, for regular contributions and standalone investments. Such is the North America sector’s dominance, it makes up 30 out of the 40 funds.
But interestingly, there are no North American funds for a £10k standalone investment over 15 years, with the UK proving to be the best bet. Standard Life’s UK Smaller Companies fund perhaps delivered the most impressive return by averaging 13.8 per cent and 12.3 per cent for regular contributions and a lump sum, respectively. St James’s Place funds also feature regularly.
The difference in asset allocation when it comes to with-profits and mixed investment funds is shown in Chart 1. Unsurprisingly, given their more conservative nature, with-profits funds have a lower equity weighting and more allocated to various fixed-interest assets. The mixed investment sector lends itself to those who are more comfortable with risk.
Despite undergoing a number of makeovers due to regulatory and product changes over the years, the coming years will be particularly testing for personal pension providers. As ever, part of its fate lies with those in power ensuring that building funds for later life is a simple and engaging process.
Mr Brown will sum up the feelings of many when he says: “The retirement savings landscape is going through a significant period of change, and the government should be conscious not to over complicate things and confuse consumers.”
These thoughts are echoed by Mr Thurlow, who also feels that an educated population will eventually appreciate the importance of funding personal pensions in addition to AE.
“People are saving insufficient amounts to create a meaningful income in retirement, but may not realise it at the moment. The risk is that they won’t start to do anything extra until it’s too late, or becomes very, very expensive.”
