How to get the pensions accumulation strategy right

Supported by
Scottish Widows
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Supported by
Scottish Widows
How to get the pensions accumulation strategy right

Education, information and communication are also important factors, but in terms of managing the long-term performance and viability of the pension pot, members must understand how contributions work, and they must also be given the security of having a robustly-run portfolio.

Contributions 

Obviously, with defined contribution (DC) workplace pensions, performance matters when it comes to the underlying investment strategy.

But are people putting enough away in a workplace scheme in the first place to benefit from any underlying investment performance?

One of the best ways in which workplace pensions help to boost people’s investments is by matching contributions.

For example, if the scheme member pays in £1, the company sponsoring the scheme may pay in £1 or £2 depending on how generous the scheme is.

With the additional contributions and the tax lift, this can help make a significant difference to a person’s pension pot at the end of their working life.

However, the age-old question is ‘how much is enough?’ Already contributions are to rise this year to 5 per cent in total, and to 8 per cent in total in 2019 with regards to auto-enrolment pensions.

But experts from across the pensions world have also suggested a 10 per cent, 12 per cent or even 15 per cent contribution is needed to ensure people have a comfortable retirement.

We need employers and advisers to continue to push member engagement through governance committees and structured financial education programmes. Sean McSweeney

Neil Adams, head of pension planning at Drewberry Wealth, believes having a conversation about contribution rates is an essential starting-point.

“Encouraging more than the minimum contribution under auto-enrolment is perhaps the biggest way in which advisers can help get the accumulation strategy right.

“The danger with auto-enrolment”, Mr Adams continues, “is that people get complacent because they know they have a pension, when in reality just paying in the minimum contributions is unlikely to be enough.”

Carolyn Jones, head of pensions product at Fidelity International, agrees it is important to "continue to make the case" for contributing more, not opting out of auto-enrolment pensions.

"It doesn’t take Stephen Hawking to appreciate the phenomenal rate of return on personal contributions as the magic duo of tax relief and employer contributions boost pension pots.

“As the state continues to tussle with the challenges of an ageing society, saving for retirement is no longer a ‘nice to have’. It is an essential part of financial planning."

And for more vulnerable groups such as women, she says this is even more important. "Women are more likely to be part-time workers or have career breaks which can subsequently lead to smaller private pension pots. Any additional help they can get to boost savings should not be turned down," she adds.

“Opting out come April 2018 will see a loss of valuable employer contributions that, quite simply, cannot be found elsewhere. Any short-term saving cost now will pale in comparison to the valuable benefits you could have had later.”

The two tables, below, show how additional contributions would work for people aged 25 and 35 respectively.

Auto-enrolment for someone aged 35

 

Total Pension Pot

Personal Contribution

Estimated income from pot at retirement

2% (Current AE duty)

£94,092

£21,506

£3,293

5% (Duty from April 2018)

£235,229

£64,517

£8,233

8% (Duty from April 2019)

£366,445

£107,241

£12,826

Auto-enrolment for someone aged 25

 

Total Pension Pot

Personal Contribution

Estimated income from pot at retirement

2% (Current AE duty)

£164,647

£32,065

£5,762

5% (Duty from April 2018)

£411,618

£96,194

£14,407

8% (Duty from April 2019)

£643,420

£160,138

£22,520

Source: Fidelity International

Investment strategy

It is also important to understand the changing face of pensions accumulation and decumulation. Since pension freedoms came into play in April 2015, people can choose when they want to take their pensions and how. 

Some people may not wish to retire at 55, 65 or even 75. They may wish to continue accumulating way past age 55 - as long as this is within the annual and lifetime allowance limits - and so the investment strategy will need to reflect this. 

Other people may wish to part-retire at 55, or completely retire; some will want to go into drawdown, some will want an annuity with a set level of annual income; others may want to take their 25 per cent cash as a lump sum and then put the rest into a hybrid of drawdown and annuity.

This means, as Tom Selby, senior analyst at AJ Bell, points out, there are new challenges that providers and advisers have been forced to react to when it comes to providing a suitable and sustainable investment strategy.

Default funds can have quite different objectives and it is worth checking whether they suit the profile of a particular workforce and any expectations in relation to growth. Peter Glancy

He explains: "Investment strategies that previously focused on reducing risk as members approached an assumed retirement date - usually the point they would turn their DC pot into an annuity - all of a sudden look out of date and inappropriate in a world where members can spend their pension how they want from age 55."

According to Mr Selby: "All of a sudden, the 'default' path for most members wasn't annuitisation but taking 25 per cent tax-free cash at 55 and leaving the rest of their pot invested."

Therefore, traditional lifestyling - by which the investment strategy shifts away from a high allocation to riskier investments, such as equities, and into less volatile asset classes such as index-linked bonds and gilts - may no longer be appropriate or suitable for modern pension investors.

For Peter Glancy, head of policy development for Scottish Widows, the first thing to consider is how the default fund has been set up.

He explains: "Large funds which pool the assets of multiple employers through group personal pensions or master trusts can have more buying power, scaled governance and more options in terms of asset choices.

"However, these default funds can have quite different objectives and it is worth checking whether they suit the profile of a particular workforce and any expectations in relation to growth."

Diversification

Part of getting the strategy right is to make sure the underlying investment portfolio is diversified properly, especially considering that millions of people who have been automatically enrolled into a workplace pension have also opted for the scheme's default. 

Avoiding home bias - a strong overweight position to one's domestic market - is a priority for many schemes, to mitigate the risk of being over-exposed to a market that could suddenly collapse, taking one's pension, currency, workplace and perhaps even bank down with it.

Getting the default fund right is just one of the "two fronts" on which the battle for good accumulation must be fought, according to Sean McSweeney, corporate advice manager for Chase de Vere.

It’s not enough to just tell people and waggle your finger at everybody. You need to show them, which is why we crunched the numbers. Carolyn Jones

He says: "We need to ensure the default fund is doing its job. There are huge variations in default pension options in terms of both risk and performance.

"This means careful consideration needs to be given to the default fund option to ensure it is competitive in the market place and that it meets the needs of the particular workforce."

Knowing your audience

Then there is the fact that some schemes have tailored their accumulation strategy not just on grounds of age of the membership but also with a view as to the financial capability and resilience of their membership.

Mr Selby explains: "For example, the National Employment Savings Trust (Nest), the scheme set up by government, went against conventional logic by putting members in low-risk investments in the early years of membership.

"Normally, advisers would recommend younger savers take more investment risk in the early years as they are better able to ride out stockmarket volatility and hopefully benefit from long-term growth.

"For Nest, however, the priority was ensuring members who might not be used to investment volatility from opting out if stockmarkets tanked just after they joined."

Communicating the benefits

Keeping employees engaged with their workplace benefits is obviously a key starting point, and this is where the employer and their corporate advisers can do more to encourage understanding and appreciation of the benefits of workplace pensions.

For Mr Adams, part of this is by conducting regular reviews with clients.

He explains: “Another way to help get the accumulation strategy right is to encourage regular reviews.

“We all upgrade our phones on a regular basis without thinking much about it, but when it comes to something as long-term and important as a pension we aren’t giving them the same treatment.

“Helping clients steer clear of a default fund not aligned with their circumstances could be part of this.”

Ms Jones states: "It’s not enough to just tell people and waggle your finger at everybody. You need to show them, which is why we crunched the numbers [as the tables above show].

"For someone who begins saving at age 35, they could lose out on the equivalent the Basic State Pension in annual retirement income if they opt out of all subsequent rises in contribution rates.

"And for 25 year olds, it is even more costly with a potential pension pot of nearly £650,000 and an annual income of £22,520 - a yearly salary that many people would be happy to have now."

Education is key, as Chase de Vere's Mr McSweeney confirms: "We need employers and advisers to continue to push member engagement through governance committees and structured financial education programmes.

"This will apply to those who select the default option and those who select their own fund options."

He says while Chase de Vere is seeking more proactive employers who do provide financial education to their workforce, this is still "the tip of the iceberg". 

He adds: "In an environment where many individuals cannot afford to pay for good quality independent financial advice, the workplace should have an incredibly important role to play in ensuring individuals make sensible decisions with regard to their company pensions and their wider retirement planning."

simoney.kyriakou@ft.com