The wrong defined contribution default fund could cost retirees hundreds of thousands of pounds in pension savings by the time they’re 55, according to a new report from JLT Employee Benefits (JLT).
According to the report, the difference in savings that can be accrued over a career can vary by hundreds of thousands of pounds depending on which fund their workplace pension is invested in. Because of this, JLT said pension investment strategies need to be a key consideration for employers who are responsible for choosing their employees’ default pension plan.
“The importance of choosing a good-quality default strategy cannot be overestimated,” said Maria Nazarova-Doyle, head of defined contribution investment consulting at JLT, in a statement. “It is tempting for employers to focus on keeping costs down, which is entirely understandable, but it shouldn’t be to the detriment of fund selection.”
JLT research found that the best-performing default funds have returned almost twice that of the worst funds, as the annualized five-year return for the default growth funds offered by the 10 main automatic enrollment providers ranges from 6.3% to 12.5%.
The report demonstrated the significance of this disparity through two hypothetical case studies. The first, subject A, is in his early 20s and earns £22,000 per year. He doesn’t yet have any savings in a pension, and he and his employer are only making minimum automatic enrollment contributions of 2%, which will increase in line with auto escalation. The second, subject B, is 30 and earns £30,000 per year. She has already accumulated a modest pension of £10,000, and makes contributions of 8%, which are close to the current national average.
Using an “extreme scenario” where the returns over the last five years continue at the same level over the accumulation period, JLT estimated the value of the two pensions at the age of 55, which is the earliest age they can draw their benefits. If invested in the best-performing fund, subject A would end up with £525,586 at age 55, and subject B would have £507,222. However, if they invested in the worst-performing default fund, subject A would have just £155,477 in pension savings at 55, and subject B would have £179,357.
“Auto-enrolment default funds are not as plain vanilla as one may think,” said Nazarova-Doyle. “The disparity in their strategies and risk-return profiles could lead to a huge retirement shortfall, amounting to the equivalent of a property.”
In 2012, the UK launched automatic enrollment, which requires employers to enroll its employees in pension funds unless the employee chooses to opt out of it. According to The Department for Work and Pensions (DWP), before automatic enrollment, approximately 900,000 employers offered very little or no pension contributions to their workers. Since the program was launched, more than 750,000 employers have met their requirements, and around 450,000 more will do so over the next few years.
According to The Pensions Regulator (TPR), 92% of workers with defined contribution pension plans are invested in a default strategy that their employer chooses for them.
This “underlines the magnitude of employers’ responsibility in selecting a good quality default investment strategy for their auto-enrolment pension scheme,” said the report. “In addition, the research found that the funds that had better returns two years ago, didn’t necessarily remain the best ones in the market, highlighting the need for employers to monitor their default fund in order to identify any drop in performance.”
Tags: JLT Employee Benefits, Pension, The Pensions Regulator, UK