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Sticking with default pension fund could mean £300k shortfall

Written by: Paloma Kubiak
Employees could miss out on £300,000 of savings over the course of their lifetime by sticking with poor performing workplace pension funds.

More than nine in ten (92%) defined contribution (DC) savers are invested in their company’s default pension strategy, according to The Pensions Regulator.

However, while savers are able to switch funds, many trust their employer has made the best choice for them, or they don’t feel comfortable making these investment decisions themselves.

But simply sitting in the default fund could prove a costly mistake. Research conducted by JLT Employee Benefits (JLT) found that the disparity in the investment performance of the UK’s top ten DC default funds is so large that savers in the worst fund could be missing out on over £300,000 by the time they’re 55. This sum is greater than the value of an average UK home, it said.

While JLT hasn’t named the 10 pension providers (only saying it was the ’10 main auto-enrolment providers’), it found that the annualised performance of these funds over the last five years (since the launch of auto-enrolment) ranges from 6.3% to 12.5%.

The 6.2% difference is stark: someone in their early 20s earning £22,000 a year starting to save into a pension with 1% contribution matched by 1% from their employer could achieve a pension pot of £155,477 by the time they’re 55 if invested in the worst default fund. By comparison, investing in the best default fund could give them a pension pot of £525,586, a £370,108 difference (based on 1% annual salary growth, fees of 0.75% per annum).

In another scenario, someone aged 30 on a £30,000 salary contributing 8% to their pension could have a pension pot of £507,222 if invested in the best performing funds. If the money is invested in the worst fund, this pot would stand at just £179, 357 –  £327,866 difference.

Huge retirement shortfall

JLT said the findings “underline the magnitude of employers’ responsibility in selecting a good quality default investment strategy for their auto-enrolment pension scheme”.

Maria Nazarova-Doyle, head of DC investment consulting at JLT, said: “Drawing from our experience advising thousands of UK employers on group personal pensions, auto-enrolment default funds are not as plain vanilla as one may think. The disparity in their strategies and risk-return profiles could lead to a huge retirement shortfall, amounting to the equivalent of a property.  

“The importance of choosing a good quality default strategy cannot be overestimated. It is tempting for employers to focus on keeping costs down, which is entirely understandable, but it shouldn’t be to the detriment of fund selection.

“Statutory contributions are set to quadruple from 2% to 8% in the next two years and this is a step in the right direction. However, this would have a limited impact if it isn’t backed up with sound investment decisions.”

Nazarova-Doyle added that it’s not sufficient to pick a good default investment strategy at the outset and let it run its course.

“Investment strategies that perform well one year can do poorly another year. Default strategies are like gardens – they need constant monitoring and tending for the best results. They need to be reviewed to ensure they remain appropriate for the type of membership of a scheme as it evolves.”

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