Pensions remain one of the best ways to accumulate long-term wealth into retirement, but if you have accumulated pensions with several different employers down the years, it might be worth checking whether they are invested in default funds.
As the world of work has evolved, it’s become extremely rare for people to go through their career with the same employer. For most people, working for different companies down the years means they have accumulated several different pensions, arranged by their employers. If this sounds like you, then you might also have chosen the default pension fund suggested by the pension scheme or pension provider. If so, you’re not alone – according to research published by the Pensions Regulator, 95% of people who have defined contribution (DC) pensions arranged through their employer are invested in the scheme’s default fund.
Whenever you start a job, you are now opted into your employer’s pension scheme unless you explicitly tell your employer you don’t want to be. If you do participate, your future pension contributions will be placed in the standard ‘default’ investment fund, and will stay there unless you decide otherwise. Employers and pension scheme trustees have a regulatory duty to ensure their default fund remains appropriate for their scheme, which means pension schemes generally take a very similar “average” approach with their employees’ money. But that doesn’t mean default funds will be the best pension option, or offer the best value, for each contributor.
It is sensible for employers and pension fund providers to encourage most people to invest in a default fund as it is designed to suit the average employee. It keeps employees invested in a pension fund which is not too aggressive, and not too conservative, but somewhere in the middle in terms of the risk profile it adopts. Furthermore, it’s low maintenance – for the employer and the employee. A default fund takes the simplest and often the cheapest route to investing a person’s pension contributions, without asking anything of the employee apart from opting in, rather than opting out. A default fund ensures the employee’s contributions are invested from day one, without them having to do anything. The fund will carry on until the employee leaves the company, or until their retirement date. Without a default fund in place, the money would be held in cash, earning a rate of growth similar to a bank account (so close to 0%).
The biggest disadvantage with staying in a default fund is that the investments within it have not been tailored to suit your individual needs. Instead, they have been chosen to meet the needs of the average scheme member. The result is that their performance tends to be disappointing for too many people. We firmly believe investments should be built around a person’s specific needs, as well as their personal attitude towards risk and preferences, such as adopting a socially responsible investment policy.
In our experience, most older default funds suffer from a lack of diversification and perhaps questionable asset allocation (the mix of assets the fund invests in). Often, the older-style default funds have an overreliance on UK asset classes, ignoring the growth potential available across other regions and global investment markets. They could also be a bit behind in terms of investing in alternative asset classes that can be valuable for diversification purposes. Default funds also traditionally don’t react to market events, and they have a fairly rigid asset allocation, which is intended to smooth returns, but can just as easily flatten them.
Additionally, if the pension scheme was set up before pension freedoms were introduced in 2015, the default fund may still be designed for purchasing an annuity that offers a guaranteed income at retirement, whereas you may be more interested in taking advantage of the freedoms to stay invested for longer.
The other big drawback with default funds is that they don’t take into account the age of the employees joining the pension scheme. This means that an 18-year-old gets placed into the same default fund as someone with just a few years to retirement. Clearly this may not be ideal for either of these employees – the 18-year-old would be well advised to take on more risk with their pension investments as they build up their retirement savings over several decades, whereas the employee approaching retirement may be better off with a lower volatility pension fund that takes fewer risks with their capital in the final few years before taking their pension.
We know from experience that people often build up a handful of pensions managed by former employers down the years, and there’s a strong likelihood that some of these pensions may be held in more traditional default funds. So, if you think this might apply to you, let us know.
We can review your current pension arrangements – especially those older pensions with past employers that you haven’t considered for a while – and work out whether you would be better off transferring those older pensions into a new pension vehicle designed specifically for you, and has been constructed based on when you plan to access your pension savings.
If you are interested in discussing pension arrangements with one of our experienced financial planners, please get in touch here.
This content is for information purposes only. It does not constitute investment advice or financial advice.
