‘Revolution’ is a dramatic word. But it’s hard to think of a better way to describe the last 10 years in pensions. We have seen the number of DC savers increase from 5.5m in 2012 to over 13m in 2019, the introduction of the charge cap, pension freedoms, the requirement for schemes to consider the financial implications of environmental, social and governance (ESG) factors, and moves to remove barriers to investment in alternative assets.
Alongside these sweeping changes, concerns have risen about the level of contributions members are making, whether investments work in members’ best interests, how charges should be constructed and whether the charge cap is too high (or too low), how to enable members to generate the best outcomes in retirement, and how to deal with the proliferation of small schemes that do not offer members value for money.
So what do we do about these concerns? Well, first of all, don’t panic. While there is clearly a long way to go, we’ve come a long way. Auto enrolment has been extremely successful, with a steady 9 per cent opt out rate. Industry has adapted eagerly to the influx of new savers, developing a range of low-cost master trusts designed for those on low incomes.
Cross-industry groups are working to develop common principles for transparency of costs and charges, the assessment of value for money, and retirement pathways for those who struggle to make informed decisions. There is clearly capability and willingness to change within the industry. It would be foolish to claim that there aren’t elements who are resistant to change, but the current degree of forward momentum means that many of these recalcitrant elements will eventually get swept up in the tidal wave.
But while we are congratulating ourselves, it is important that we don’t become complacent. There is a long way to go before we can rest assured that members are getting the best possible outcomes from pension saving. This year’s edition of the Pension Policy Institute’s DC Future Book explores how current trends, if progressed, could increase the size of the pension pot of a hypothetical individual, Sam, who contributes 8 per cent of salary to his pension pot between age 22 and state pension age (SPA).
Sam could take his pension savings in a wide variety of ways during retirement, including drawing income directly from his pot, taking a lump sum, investing through a drawdown contract, purchasing an annuity, or a combination of these. The level that Sam’s contributions are de-risked through moving from more volatile, high return-seeking assets, such as equities, to lower volatility assets with lower return opportunities will affect his retirement outcomes. If Sam’s contributions are significantly de-risked and then re-invested at retirement, he may forgo some return opportunities. If Sam’s contributions are not de-risked, and suffer market losses prior to access, he could get a lower rate on an annuity.
An alternative approach to de-risking is to use less volatile assets, such as real estate and infrastructure, which allow similar returns to equities and therefore reduce the need to de-risk significantly before retirement, yielding a pension pot which may be more suitable for a variety of uses. If Sam’s contributions are invested in a fund using alternative assets, and de-risked at a later date than pure equity/bond split funds tend to be de-risked, then the size of his pension pot in retirement could be increased by 3 per cent.
The use of illiquid funds and investment in funds that take account of the financial implications of ESG also have the potential to boost Sam’s pot size by 2 to 3 per cent. And a drop in charges, arising from scheme growth or consolidation could see Sam’s pot size increase by between 6 and 8 per cent. Behavioural changes, that could be prompted by guidance or through behavioural nudge policies, such as increasing contribution levels and/or longer working also have a significant impact, increasing Sam’s pot size at SPA by 13 and 5 per cent respectively
The future of people like Sam lays in the hands of policy makers, regulators, industry and support agencies. Trustees and IGCs are in a key position to help maintain the momentum that is already in train. Lots of good work has already been done, let’s just keep calm and carry on.