The majority of these people are in defined contribution schemes and rely on their employer and/or pension provider to decide how best to invest their money.
There is different legislation governing default strategies for workplace pension schemes depending on whether the product provider offers a contract-based plan or a trust-based scheme.
Under the previous UK Government, an agreement was established setting out aspirations for the largest pension providers to invest 5% of their default investment strategies into unlisted equities by 2030.
In November 2024, the current Government announced it will broaden out this initiative using legislation in the form of a new Pension Schemes Bill in 2025.
Andy Robbins, senior employee benefits consultant at Mattioli Woods, explores considerations of the following default strategies:
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- Lifestyle strategies
- Target date funds
- Illiquid assets
Lifestyle
Lifestyle strategies aim to deliver growth by investing the pension scheme members’ funds in a greater proportion of equities in the early years, with a gradual movement into lower-risk, less volatile assets in the later years as they approach retirement.
There is a general consensus that most pension scheme members can tolerate greater volatility with their investments while they have a longer term to retirement than those who are getting closer to retirement and wouldn’t have the opportunity to make up any losses. After all, people getting closer to needing to access their pension fund for income need greater certainty at this crucial planning stage.
It is important to know if you are in a lifestyle strategy, as pension providers tend to use a number of pooled funds at each stage throughout the life of the plan. The lifestyle switching process is an automated mechanism that usually happens gradually and passively over time.
From a positive perspective, automation provides security to the scheme member that their pension will be less exposed to adverse equity markets as they draw closer to retirement. This process allows for a smoothing of any adverse movements in the stock market.
Conversely, automation does not allow for adjustments during any period of prolonged adversity, such as the issues experienced in the bond markets in 2022, nor does it factor in unexpected early retirement. You may also want to delay taking income and rather keep it invested.
Target date funds
While lifestyle strategies are used by the majority of pension providers, there are a few who use target date funds (TDFs) instead. TDFs aggregate members by retirement age; for example, those reaching age 65 in 2025. Their investments are placed by the pension provider into a single fund that is managed by an investment team.
One of the key benefits cited by the pension providers using TDFs over the traditional lifestyle strategy is that the TDF allows for active management of the asset allocation during the years approaching and through retirement. This avoids issues such as disinvesting during adverse investment climates and also takes advantage of potential investment opportunities should they arise.
However, this active management oversight requires a significant amount of resource and cost to ensure that active decisions do not create unnecessary risks for the pension scheme members.
There are also risks where a member takes benefits earlier or later than the age stated on their policy, the investment strategy that is in place – be it a lifestyle strategy or a TDF – will not be matched as it should be from an asset allocation perspective, which could mean being exposed to an increased level of volatility if taken earlier, or an insufficient chance of growth where taken later.
Illiquid assets
Illiquid assets are types of investments that are not as easily realisable as cash and therefore cannot be traded easily in the short term. In the 2024 Mansion House statement, the Chancellor outlined the objectives of legislative change in order to free up funds from UK pension providers to invest in new UK businesses (unlisted shares/private equity), infrastructure and local projects, all of which can be classed as illiquid assets.
When investing in private equity, returns can often be great, as are the risks associated when companies fail or underperform. Infrastructure projects can take a long time to come to fruition, without any realisable returns in the short term. The cost to the pension provider of investing illiquid assets and therefore the charges that the members ultimately pay may also need to increase, up to a legislative cap.
The Government is therefore proposing that only so-called mega funds will be sufficiently capable of using these types of investments to generate good outcomes for members.
What should you do?
While your employer chooses the type of scheme and investment strategy it has, the responsibilities for structuring the default strategy sit with the pension provider of the workplace pension. As a pension scheme member, you should undertake the following actions:
- Check your pension scheme and what type of default strategy it has
- Ensure the type of default strategy matches what you will need at retirement
- Keep your pension and retirement age under review
Andy Robbins is a senior employee benefits consultant at Mattioli Woods
