DC: Not as Bad as We Might Think

Overall contributions average 10% across UK’s FTSE100 companies and most charge less than 0.5% in fees.

(May 28, 2013) – Good news from the land of defined contribution (DC) – large employers are paying an average of 5.1% into their staff’s DC schemes.

Where employers provide the same contribution rate for all members, their contributions average 9.3% of pensionable pay, but it’s far more common for employers to vary their contributions according to how much employees are prepared to pay themselves.

Across the UK’s FTSE 100 employers, the average core employer contribution is 5.1%, with a further 5.1% available for members who take full advantage of matching contributions, taking the total to more than 10%.

The new statistics, unveiled by consultant Towers Watson, also showed that annual management charges were no more than 0.4% of the member’s account if they stayed in the default option, and that where companies automatically enrolled their staff into the DC fund more than 90% stayed in it.

Interestingly, DC funds which are overseen by trustees, as opposed contract-based funds, tended to have a smaller range of fund choices.

This seems to be a positive, as where fewer options were offered, members were more likely to actively choose their investment options. This echoed recent research on the outcomes of 401(k) funds, which showed that less is more.

Some 67% of contract-based schemes offer more than 50 investment choices, whereas 75% of trust-based schemes offer between five and 15.

Nico Aspinall, head of DC investment at Towers Watson, said: “Sometimes, more choice can mean less choosing. Selecting an option from a long list can appear more daunting. One third of contract-based schemes are now offering a narrower core fund range alongside the full menu in order to combine a manageable choice for most members with greater flexibility for experienced investors.”

Further good news was found when it came to charges levied by the funds on members:  74% of DC funds said that the Annual Management Charge (AMC) in their default investment option was 0.4% or less, a marked increase when compared with the 53% recorded in 2012.

There was little difference in fee levels between trust-based and contract-based funds, overall, the average AMC is 0.33% in trust-based schemes and 0.37% in contract-based schemes.

However, the gap is wider (0.22% and 0.38% respectively) if the comparison is confined to purely passive investments. 

The research comes at an interesting juncture for DC in the UK – last week, the Department for Work and Pensions said it would consult in the autumn on whether a charge cap should apply to the default investment option in all DC schemes.

But Towers Watson’s senior consultant Will Aitken said a charge cap may not make much immediate difference for large employers, and risked stifling innovation in investment strategy, given the best ways of balancing risk and return are often more expensive to implement.

One area on which all agree is that defined benefit (DB) has had its day in the UK – 34% of FTSE100 companies now have no employees who will receive DB benefits, including 27% who used to, but have now completely closed their schemes.

While closing to existing members is not yet quite the norm, there is evidence we are proceeding down that path.

“If the pace of hard closure seen in recent years continued, all FTSE100 companies’ schemes would be completely closed within a decade,” said Aitken.

“Bigger than expected deficits and the loss of National Insurance rebates from 2016 may lead more employers to do this sooner rather than later.”

Related News: Finding the Sweet Spot for DC Diversification and More 401(k) Options Mean Worse Outcomes