Amid all the debate about pension charges, DC schemes’ shortcomings and the merits of auto-enrolment, the simple message for employees is tosave more
There is a storm raging around charges associated with pensions saving. Now, I’m all for punters getting value for money, but that is a long way from claiming all pensions are a ‘rip-off’.
The perception of being short-changed is partly the fault of poor government legislation, but some blame must be laid at the door of the financial services industry, which is so adept at shooting itself in the foot.
What do I mean by that? Well, the introduction of stakeholder pensions in one fell swoop radically altered the charging structure for financial products in the UK. This was the fault of the government because it focused on cost over value, which resulted in a market that had little incentive to service these products.
But the industry was also culpable for allowing this to happen. It has resulted in the debate forever returning to cost rather than value and the ultimate prize of a meaningful retirement fund is often forgotten. And now, as we stand on the precipice of possibly the greatest economic enfranchisement of the working population since the introduction of the old age pension, the argument has been rekindled when, actually, the issue of cost is irrelevant if what you are paying for isn’t worth a light. And unfortunately, that has been the case for very many defined contribution (DC) schemes in the past.
In our cover story this month, Jonathan Lipkin, associate director, pensions and research at the Investment Management Association, agrees that the issues surrounding pension default options are important because they will create millions of ‘accidental investors’. However, he says, far more important are the risks of not saving enough and not taking enough risk; allowing for individual risk profiles and the length of time an individual has until retirement, of course.
Knowing that DC pensions offered to staff in the past have not been fit for purpose, employers are looking for a better way to help staff save for retirement. Some will build a default to cover all eventualities; some will offer two-tier schemes; others will offer a wide range of choice. Some will do a bit of all of these. But most are looking to reduce the burden of risk faced by individual members.
There are well-founded fears that benefit statements showing auto-enrolled investors that their current fund doesn’t even equal the amount they have paid in will result in a mass exodus at renewal time. Some say risk profiling should be integrated into the default process to determine an individual’s attitude to risk so they can be given an appropriate asset allocation.
Of course, that has to be done in a fairly sophisticated way, but without providing face-to-face advice for every member. The trouble with risk profiling is you need an engaged investor. Even if they only have to complete five multiple-choice questions, they have to want to do it and the truth is that 90% of employees fail to engage with their pension savings at all. This is why defaults are so important, but it is also why some employers are considering multiple default funds to cope with the requirements of different segments of their workforce.
But whatever comes of the default debate, it is all for naught if people don’t save enough. Contribution rates are the single biggest influence on staff receiving a meaningful retirement fund. Unfortunately, the fact that auto-enrolment introduces a government-prescribed minimum will mean the vast majority of those who do not opt out will think they are saving enough. They are wrong, but they are not wrong for thinking this is why the government is introducing auto-enrolment.
Saving something is better than saving nothing, but saving more is better still. I believe employers who concentrate on getting their staff to save more into their workplace saving structures are likely to have fewer governance issues or succession planning headaches than those who try to turn them into sophisticated investors.
Rather than spending a fortune on communications around auto-enrolment, I’d be inclined to get back to basics and do something that isn’t even taught in schools any more: to demonstrate the mechanism and explain the potential power of compound interest.
Padraig Floyd is contributing editor of Workplace Savings Quarterly
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