It is ironic that the pensions inertia which has resulted in low automatic enrolment opt-out rates also leads many of the auto-enrolled to not take an active interest in their retirement savings.
Research consultancy Decision Technology’s recent report, Damage by Default: The flaw in pensions auto-enrolment, estimates each employee stands to lose out on an extra £700 a year from 2019 – or £9bn a year in total – by staying in default funds rather than engaging with their pensions and investing elsewhere.
Default funds are designed for employees as a group and have capped annual charges of 0.75 per cent. However, Decision Technology’s report says this one- size-fits-all approach cannot meet employees’ varying needs.
The firm wants the Government, pension providers and employers to focus on consumer engagement in terms of fund choice as well as the need to increase contributions. The idea is more people could potentially increase their savings
by moving out of the default option and into other funds more suited to their needs.
But does the wider industry agree auto-enrolled workers need to be encouraged to look elsewhere?
Don’t run before you can walk
Many commentators believe the priority for auto-enrolment should remain getting contributions up, not over-complicating matters with investment choice.
Tisa director of policy Adrian Boulding says: “We’ve all heard the phrase: don’t run before you can walk. Change that into pension terminology and it becomes: don’t worry about investment choices until realistic contribution levels have been achieved.
“The primary factor which influences the size of a pension pot is the level of contribution. The underlying investments play a part but growth is restricted by the amount of money invested in it.”
Royal London director of policy Steve Webb agrees. He says: “Sometimes we worry so much about the details of pensions we lose sight of the big picture. Unless we get a big increase in contribution rates over the coming years, millions of people will have to work much longer than they want or retire much poorer than they expected.”
That said, others believe the concept of fund choice does need to be introduced at some point, if only to ensure employees know what they are investing in and what their fund is trying to achieve.
Intelligent Pensions technical director Fiona Tait says: “As the auto-enrolment market develops, both the industry and scheme trustees should look at ways to encourage people to make more individual investment decisions, particularly for those approaching retirement where defaults and one- size-fits-all options are much less effective.”
In defence of defaults
Default funds do have their limitations. Critics say they may not provide enough risk for people that are a long way from retirement while being too risky for people who are risk averse.
However, on the whole, the industry is against the idea of encouraging auto-enrolled workers to invest elsewhere.
JLT Employee Benefits head of DC investment consulting Maria Nazarova-Doyle says: “When default funds are created by providers and advisers, great care is taken to ensure these strategies are aiming to provide good pension outcomes for savers. While these funds are not taking into account each person’s individual circumstances, they are a very good approximation for a group of people in a particular scheme.
“We should not be encouraging auto-enrolled workers out of default funds, as the majority of them do a very good job. Unless savers are investment professionals themselves or take investment advice, leaving the default arrangement to choose their own investments is unfortunately more likely to result in less money in retirement.”
However, Punter Southall Aspire DC investment consultant Christos Bakas points to research suggesting default funds currently in existence could be improved.
He says: “In July last year, we analysed nine major default investment funds operated by the UK’s largest defined contribution pension platform providers and found a wide variety of approaches in the risk and volatility profile, return benchmarks, asset allocation strategy and level of active management.
“Many employers assume that default funds are constructed in a similar way and will achieve similar outcomes, but the data told us this was not the case.”
Question of advice
So is it worth an individual seeking advice on whether to look beyond their default fund? According to Savage Silk financial adviser Declan Harrington, the issue comes down to timing.
He says: “Who in our industry really believes that individuals with savings of perhaps £500 or £1000 need or would welcome advice regarding fund choices? Surely,
we need to let people have at least 10 years of building worthwhile savings before muddying the waters by trying to sell them today’s latest thing.”
There is, of course, also the question of cost. Advice fees could be a problem for auto-enrolled workers with lower salaries and small pension pots.
Wealth Wizards director Phil Blows recognises most people have no idea what they need to do about retirement savings, nor what their pensions are investing in. But he does not blame people for not engaging with their pensions if they do not have access to the help they need.
He says: “There are around 20,000 advisers for nine million people who have auto-enrolled. Unless people have a couple of hundred grand they are never going to get the help they need. Default funds are the better option for people who have no experience of self-select, which some people see as ‘self-harm’.”
Decision Technology director Henry Stott says the fact that regulated advice will not be cost-effective for most means it is down to providers to find ways to help people engage and self-select.
If moving out of default funds was to be encouraged, Bakas believes employers would also have a role to play in providing ongoing support for those who chose to select their own funds. But he warns that it is a dangerous area.
He says: “The danger is that if the support provided is just a one-off, then individuals will select a fund and never review it again. This would be worse than them staying in a well-governed default fund.”