For many, the company pension will be the bedrock of their retirement nest-egg – but in years to come, many will have to take a more active interest in how their pension pot is growing and who is running it.
Understand the scheme
Two types of schemes are found in the UK’s workplaces: defined benefit, or final salary, and defined contribution, or money purchase. In a defined benefit scheme the pension is determined by the employee’s salary at retirement (or when they leave employment) and the years of service. The scheme, backed by the employer, shoulders full responsibility for investing pension savings and making pension payments. However, these schemes are expensive for employers and are rapidly disappearing. They are being replaced by defined contribution where the worker, or member, takes of the risk of growing their investment pot and turning those savings into retirement income, usually by purchasing an annuity. Employees are not normally given the flexibility of having an employer’s contribution paid into a scheme outside the company plan.
Check the default funds
Most employer-provided defined contribution schemes automatically place members into a “default fund”. Most employers will offer a range of funds to suit varying risk profiles from higher risk, to lower growth. Many more employers are also offering alternatives such as ethical funds and funds that are compliant with religious principles such as sharia.
Default funds work on the basic principle that most members want decent returns without big market swings hitting growth, so they are usually “cautious balanced” funds. But such “one size fits all” products don’t take into account individual needs or market circumstances. For example, if your funds are “lifestyled” at the beginning of a market upturn, you will lose out on the upside.
There is no such thing as a typical default fund. Each fund is individually chosen by the employer or plan sponsor. What is chosen for a workplace will depend on a range of factors including the average ages of staff, their income levels and assumptions about their risk profiles. Passive tracker funds are the most common type of default fund offered in UK workplaces, followed by multi-asset and diversified growth funds.
Investors may wish to check they are comfortable with the amount of risk and return within the default fund as there is often a more cautious or more adventurous fund offered as an alternative
Consider switching to other funds
In a defined contribution (or money purchase) arrangement, the pension you get when you retire will be related to the performance of your investments as well as how much you contribute and the charges. So it makes sense to keep an eye on all three factors.
For example, over 20 years the average managed balanced pension fund has turned £10,000 into £34,650, according to Hargreaves Lansdown, the independent financial advisers.
But the Axa Framlington Managed Balanced fund, managed by Richard Peirson since 1994, has turned £10,000 into £52,260 over the same period, a 70 per cent better return.
“The reality is that the Axa Framlington Managed Balanced fund will never be used as a default fund because it costs 1.2 per cent per annum, but it has been a far superior fund to typical insurance company defaults, which usually cost 1 per cent or less,” says Laith Khalaf, head of corporate research at Hargreaves Lansdown.
“If investors want access to this kind of quality fund management, they almost invariably have to step out of their default arrangement.”
Most employers, and plan sponsors, will offer web-based risk profiling tools to choose the right fund for their investment goals. Individuals are also free to seek independent financial advice.
You need to be aware of the charges applied to the existing funds and whether the growth potential of alternatives supports the charges levied. Bear in mind that there can be default funds which are well chosen and those which are less well chosen, which may have higher charges and lower opportunities for growth.
However, some investors will be happy with the “hands off” approach of a default fund.
Monitor your pension funds
Gone are the days of waiting for an annual pension statement. Many scheme members can now access their account online at any time. Many employers also use text messages to prompt pension scheme members to keep an eye on their pension pots.
Most experts recommend that at least five to ten years ahead of retirement, savers let their trustees, employer or providers know when they expect to retire and what their intentions for their pension pot at retirement are – usually an annuity purchase, but there are other options for bigger pots.
The questions to think about are: do I want to take out the maximum 25 per cent tax-free lump sum? Do I want to buy an annuity? Am I interested in income drawdown?
The answers to these questions will impact on which de-risking approach is the right one ahead of retirement and whether your investment strategy is right.
Charges and lifestyling
Because employers can negotiate lower charges than individuals, company pension costs are usually very competitive compared with personal pensions. That said, they can still vary widely; at larger employers, they may be as low as 0.1 per cent. Fees of 0.3-0.5 per cent are about average, but they can be 1 per cent or higher for small company schemes.
Lifestyling is a common investment strategy, often adopted in default funds. This is where a member’s pension fund is gradually moved into lower risk assets, such as gilts, corporate bonds and cash, as the member approaches his or her retirement date. The idea is that reducing risks helps protect the value of their fund. However, the recent decline in bond prices (and increase in yields) has prompted some debate as to whether lifestyling is appropriate in all cases.
Another strategy is the retirement date or target fund. These strategies operate on a formula based on when you will retire, or state pension age, for example, and adjust asset allocation as you progress towards retirement.