If you read nothing else, read this …
- The primary responsibility for a defined contribution pension default fund strategy lies with the sponsoring employer.
- Employer responsibility is particularly important for contract-based schemes even though the employer role is implied.
- A board of trustees will have responsibility for the default investment in trust-based schemes.
- Employees do not have to be investment experts, but should engage with whether they are saving enough in the correct choices for them.
The bad news is that not everyone is clear where ultimate responsibility for that strategy lies. Is it the employer? Or its adviser? Or its pension provider? Or the fund manager?
There is a growing trend to believe that legal responsibility for a defined contribution pension scheme’s default fund is mainly in the hands of the employer.
Sarah Smart, chair of The Pensions Trust, says: “The responsibility lies with the employer, in that it should choose a fund that fits its own requirements for its staff and its knowledge of how much effort it can put into overseeing that.
“If an employer knows it does not have the time or capability to oversee [the fund], it should make sure it uses a fund where that oversight will be provided for it.”
Lack of clarity around employer responsibility for the default fund is most pronounced in contract-based pension schemes, in which the contract is between the employee and the pension provider.
But Karen Partridge, chief business development officer at Anthony Hodges Consulting, says employers cannot wash their hands of responsibility for default strategy. “In contract-based pensions, the employer should take responsibility in ensuring that the default will provide employees with a safe investment because that is the assumption that the employee will make,” she says.
Implied responsibility for contract-based schemes
“I think there is an implied responsibility. With the schemes we deal with, 90% to 95% of employees are in the default fund. There is an assumption that, because it has been chosen as the default fund, it is a safe option.”
The problem is exacerbated because the contract is between employee and provider, so there is little the employer can do if an employee is signed up to a particular fund.
Morten Nilsson, chief executive officer of Now: Pensions, says: “Contract-based schemes are subject to a different legal structure, which means that, although the default investment strategy may be amended, it is generally not possible to switch members into a new strategy without individual written consent. That restriction can result in many members remaining in outdated and possibly expensive investment strategies.”
Responsibility falls onto different shoulders when it comes to trust-based pension schemes. Here the board of trustees, which may include employer, employee, external and union representatives, is legally responsible for any investment decisions.
Even though the trustee board is independent of the employer, it is the employer that has responsibility for ensuring the right trustees are in place and that they have proper support. The Pensions Trust’s Smart says: “If it’s an in-house scheme, the employer should be making sure it puts in place trustees that are capable of making the right selection of the investments available.
Selection of investments is a skilled job
“It is not an employer’s job to know which selection of investments is right for members. It is a skilled job and that is the job of trustees or pension providers. But it’s the employer’s job to choose the right scheme.”
In organisations that have switched from a trust-based to a contract-based pension plan, there is already a culture of the employer being responsible for investments. Anthony Hodges Consulting’s Partridge says: “It is almost a more natural transition for them to assume responsibility for the default investment.”
In multi-employer trusts, an independent board of trustees is responsible for the default investment strategy. Now: Pensions’ Nilsson says: “The trustees may take input from the scheme manager and seek external advice as appropriate, but they have the power and the duty to review investment strategy regularly to ensure the default approach is always the most appropriate for members’ needs.”
The pension changes announced in the Budget 2014 in March will give employees more responsibility for their own retirement outcomes. Equally, the changes should ensure staff have some level of awareness of their savings strategy during the time they are building a pension pot.
Financial education for staff
Smart adds: “I am not of the view that employees have to have a high level of financial education, but they do have to look at how much is going into the scheme, they have to think about what their situation will be when they get older, and whether those two things match up.
“A good scheme will provide them with support for thinking about those things. I don’t think it’s a question of employees knowing where they should be invested. But if they are minded to do that, that’s great.”
Partridge adds: “There is an entitlement culture in the UK: that they will be looked after by the state and by their employer. We have that mindset because of the state provision, which is not means-tested, and the legacy of DB [defined benefit] pensions.”
Because of this cultural mindset, employers have a particular responsibility to select the most appropriate default investment strategy for their workforce and be able to justify, in years to come, why they, as sponsoring employer, made that decision.