Why one size doesn’t fit all when it comes to your pension fund’s default option

Andrew Mence

Workplace pensions have been around for many years. Today, they’re more valuable than ever.

In a time of low unemployment and a skillset shortage, employers are offering better benefits to retain and attract talent – over and above the basic salary.

On the surface, workplace pensions are a great place to start, as they build a basic fund for the future and they have kickstarted retirement savings for younger generations who might otherwise have neglected them.

However, those of us working in financial planning or who are active financial planning clients know that we’re all in unique situations. In order for our finances to be as effective as they can be, we require advice that recognises that distinction.

The further down their retirement journey that someone is, the more likely they are to require a personalised retirement plan.

The state of play

Currently, an employer must contribute 3% of an employee’s qualifying earnings into a pension. If we put this into monetary terms and assume it is just salary in this case, based on the average salary across the UK, this is £1,158 per annum boost to pension pots. In addition to this, as an employee, you’re making a minimum contribution of 5% of your qualifying earnings (again, some assumptions, so £1,930 per annum). Combined this is £3,088. Please, ask yourself the following:

  • What are you contributing into?
  • Will saving £3,088 per annum really fulfil my future aspirations?

According to the Pensions Regulator, 96% of employees are invested in the pension scheme’s default strategy. What does this mean? Quite literally, it means you are doing the same as the person sitting next to you. Your aspirations outwardly are no different from 96% of the rest of the population. Years in financial planning tells me this simply isn’t true.

The Financial Conduct Authority (FCA) set out its guidelines as recently as November 2021 where it “wants default funds that are fair value” and achieve a “better pension outcome for consumers choosing a default option than they could otherwise achieve”.

As 96% of us use the default fund we should know a little about it. All the major Workplace Pension providers have Independent Governance Committees which provide oversight of the Default Fund and ensuring they comply with the Pension Regulator’s requirements.

However, pension providers have differing views on many factors, such as the investment style to be used (active v passive), the equity exposure of the fund (this can range from 40% – 85%) and the timescale over which investments will de-risk (reduce risk) as an employee approaches retirement.

Returns across default funds can also vary widely. For example, a study by the Tax Incentivised Savings Association in 2019 found the performance of the 20 largest pension provider default funds over 3 years ranged from 3.4% – 11.9%. In monetary terms, this means:I should caveat the return and investment timescale here. It’s unlikely a fund will return 11.9% annually over 30 years and pension investments are made for the long-term, which can mean the default fund investment performances will fluctuate a lot in that time period – a three-year snapshot is very much a moment in time. For example, some providers will have more exposure to equities than others, and some may not have hedged (protected) their foreign currency exposure, so this will have a short term and dramatic impact on performance levels. What’s more, someone starting out in their career could realistically expect to be invested for 40 years at least.

However, it illustrates the point that if you find yourself in the wrong default fund the consequences are potentially life-changing. What’s more, you’re not in control.

Those who need to build wealth and have the time to do it should to be in more adventurous funds and an independent financial planner can advise on the most appropriate mix. Conversely, some may not need the risk to be that high if they have other means of funding their retirement – the point is that the default fund provision doesn’t account for any of this, whereas a financial planner will.

This leads me into my secondary question. Will saving the minimum requirement into a pension fulfil your aspirations? Research by Which? magazine suggest couples are spending around £28,000 per annum and living a comfortable lifestyle. To fund this savings of £843,8813 (in today’s terms, HL Annuity Rate Table: Jt Life 50%, 60, 3% escalation, no guarantee) might be needed. To achieve this, in the current inflationary environment, employees and savers alike will need to consider some hard and potentially unpalatable options.

Typically these might be:

  1. Do nothing
  2. Increase the amount being saved or improve tax efficiency
  3. Compromise on expectations
  4. Increase the amount of risk

Aside from the first option all of the above require self-awareness and a willingness to engage. This is a major challenge and society’s apathy is demonstrated by passiveness surrounding retirement savings. Few employees increase their savings provision; some don’t know who their pension provider is and most have little idea of how their savings are invested.

At Wren Sterling, our Corporate team works proactively with our employer clients to help improve engagement so that people are actively interested in their futures and we find these financial education sessions “wake up” people who have been sleepwalking towards their retirement. Challenging their ideas of what a comfortable retirement looks like and how likely they are to reach it does jolt people into action.

Auto enrolment has proven successful to the extent that more employees have started saving and at least giving them a chance of retiring with something.

It is the role of all of us who recognise the value of independent financial planning to encourage our friends and family to take advice on their circumstances because the stats say people are not doing this themselves. For example, if you have children who are not financial planning clients, speak to your financial planner as we can often look after them as we do you, in a family arrangement.

Or, if you’re a company director or senior manager and you want to emphasise the value of engagement with pensions to your employees, please speak to your financial planner for a referral to our Corporate team.

We can provide independent financial advice that sets out a bespoke financial plan to help you achieve your aspirations. But, please remember, at the end of the day no matter what anyone tells you there’s only one person who can get you from Starting Point A to End Point B – and that’s you.The Financial Conduct Authority do not regulate auto enrolment.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

Andrew Mence
About the Author

Andrew has spent over 17 years accumulating considerable experience providing financial advice, helping individuals create wealth, retire and pass it on to future generations. Andrew focuses on building a deep understanding of his clients' objectives and what makes them so important as this enables him to tailor bespoke financial plans designed to achieve these goals. Andrew’s clients are a combination of business owners, professionals and retired individuals – many of whom he’s worked with through the course of his career. Outside of work Andrew is happily married, an avid ball sports fan and to keep fit is willing to take on challenges to raise money for various charities.