PwC says two decades of underperformance for defined contribution schemes has left employees with less money than they put in. It says poor equity performance, which has left some money purchase pension investors worse off than cash even after 20 years contributions, has left employers facing a dilemma between defined benefit schemes with risks they cannot bear or DC schemes which are not delivering.
The firm cites the example of a 50 year old who has been paying 5 per cent of salary totalling £250 a year for the last 10 years into a DC plan. If the individual had invested in equities, £24,000 worth of contributions would now be worth £21,000, an annual loss of 3 per cent a year, and far less than cash.
A 55 year old today who has been paying 10 per cent of salary, totalling £600 a month for the last 20 years who has adopted an equity-based investment strategy would have invested a total of £94,000 in contributions and have built up a pot worth £130,000. This represents an average annual growth rate of less than 4 per cent a year, still less than a cash investment would have returned over the period.
Raj Mody, partner and chief actuary at PricewaterhouseCoopers says: “Employers are left between a rock and a hard place. It is no surprise most companies now offer defined contribution schemes, given the unsustainable risk and cost of defined benefit provision.
“Other scheme design options exist in principle but legislative change would be needed to make them work in practice for employers and employees. These designs operate by, for example, spreading risk between members as a collective group. This would still allow employers to control costs but give better predictability of retirement income particularly for older employees.”
“This situation leaves members of defined contribution schemes, who now outnumber members accruing benefits in defined benefit schemes, with some fiendish challenges. If the timing of their retirement coincides with a period of reduced pension value, they may have to extend their working life significantly.
“Individuals need to strike a balance between investing in riskier assets which may or may not deliver a higher pension, versus choosing lower-risk and lower-return investments but having to contribute much more to secure an adequate income in retirement.”