Pension warning for 10m workplace savers

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Pension warning for 10m workplace savers

A startling report, published by Interactive Investor and consultancy LCP, has warned that unless workers take drastic action to boost their contributions, they could be heading towards a serious shortfall in projected pension income at retirement. 

The 19-page report, called 'Is 12% the new 8%?', has warned that up to 10m Britons in defined contribution schemes - where the saver bears all the investment risk themselves - are at risk of not getting anywhere near what they might be led to expect.

According to the report, the lower-for-longer environment of low interest rates, low bond yields and restricted stock market growth means a 22-year-old starting to pay 8 per cent into their DC pension now would receive £46,000 less than a 22-year-old putting 8 per cent into a pension in 2007. 

The impact of inflation and charges adds a whole other layer of complexity and the potential for further erosion of expected returns. 

We’ve entered an age of responsibility, where more and more people have now become investors.Dan Mikulskis

The report claimed even if someone put in 12 per cent a year, this would only just allow them to match the sort of income generated by someone who started investing in 2007, based on 2017 growth assumptions. 

As the report put it: "A decade of falling returns since [2012] means that simply to stand still relative to those original [growth] assumptions, a minimum 12 per cent would be required."

Based on the Financial Conduct Authority's real rate of return for major types of investments over five-year intervals since auto-enrolment came into effect in 2012, it is clear there has been a significant drop in expected growth, based on a simple portfolio split between equities and bonds (see Table 1).

Table 1: Weighted average real rate of return on an illustrative pension pot based on growth assumptions in a) 2007, b) 2012 and c) 2017.

 

2007

2012

2017

    

Weighted average rate of return

4.2%

3.5%

2.4%

Source: LCP; weighted average real rate of return for a portfolio comprising 60% equities, 20% corporate bonds and 20% gilts.

According to Becky O'Connor, head of pensions and savings for Interactive Investor, this would make a significant difference to the expected outcome for people in workplace pensions, based on the age at which they invested. 

She said: "Lower-for-longer investment growth could mean the difference between scraping by and being comfortable in retirement, but the effect of stock market performance on retirement outcomes may be poorly understood.

"Now we live in a potentially lower-growth world, this needs to be reflected in recommendations for higher minimum pension contribution amounts." (See Table 2).

Table 2: Size of illustrative pension pot at different ages based on real rate of return of a) 4.2% and b) 2.4%

Age

4.2% return

2.4% return

Difference

40

£32,433

£27,442

-15%

60

£103,895

£70,947

-32%

65

£131,298

£84,604

-36%

70

£164,077

£99,595

-39%

75

£203,286

£116,052

-43%

Source: LCP

Dan Mikulskis, partner at LCP, commented that while commonly used assumptions from providers and advisers might expect annual returns of approximately 5 per cent for stock markets over the long-term, and less for bonds, individual investors expect more than this.

However, they need to do more to make up for shortfalls and to start asking more questions over the make-up of their pension funds and understand how the money may grow over time.

He said: “We’ve entered an age of responsibility, where more and more people have now become investors, responsible for their own financial security. Looking under the hood of investment products and asking questions like: ‘How much of my assets are invested in stock markets? How much in bonds?’ is vital.

“The industry needs to step up and do better to help investors be realistic here, getting past the jargon and sales guff to actually help produce tools that help savers understand how their money may grow, and the impact of things like inflation and fees over the long term.”

The report also touched on inconsistencies in projections quoted on pension statements from different providers, which can lead to confusion and difficulties making financial plans.

As reported in FTAdviser earlier this month, independent trustee and governance services provider PTL warned that outdated DC models could lead to an impoverished retirement for many people.

Calling it a "catastrophe" in the making, PTL claimed most workplace pension plans were being built based on defined contribution adequacy models that were outdated and overlooking some "major factors". 

simoney.kyriakou@ft.com