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Since the Pensions Act 2008, employers in the UK must put employees on a workplace pension (via auto enrolment). Yet the quality of these workplace pensions is not universal. Indeed, 17m of the UK’s workforce has a pension invested with at least one of the three largest pension providers – yet experience varying returns. Given that even a few percentage points difference in pension performance could dramatically impact your retirement savings, how can you make sure your workplace pension is giving you the best deal?
In this post, our team at Cedar House shows how workplace pensions work, where they can fall short of expectations and what options are open to UK employees. We hope you find this content useful. If you want to discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
Auto enrolment pros & cons
Many people are not saving anywhere near enough for retirement. The Department for Work & Pensions (DWP), for example, states that around 12m people are not fully on-target to reach their retirement income goals. As such, the auto enrolment rules – which require both employers and employees to save for the latter’s retirement – are arguably a good thing. In 2021-22, the former is required to contribute at least 3% of the latter’s salary into their workplace pension, and the employee must put in 5% at minimum.
However, whilst auto enrolment rules stipulate who must contribute to a pension – and minimum contributions – they are less specific about quality control for pension providers. This opens the possibility that savers’ returns do not stretch as far (due to poor investment choices) – as well as the chance that returns get eroded by high costs, such as investment management fees.
Why percentage points add up
Does it truly matter if your workplace pension scheme charges more than another, or if it offers slightly lower returns? The answer is yes. To give an example, suppose you contribute £300 to your workplace pension over 20 years. Then, imagine that your average “real returns” (after inflation, fees and performance) each year are 4%. By the end of 20 years, the value of this pot could be worth over £109,000. However, suppose instead your average real returns are 6%. In this case, by the end of the investment period the pot could be worth £136,000.
With a better investment strategy, wider fund choices and cheaper fees, therefore, you could gain £10,000s more in retirement. The problem, of course, is that workers have little say over which pension scheme their employer chooses – which has a big impact on your wealth growth potential. Indeed, the larger the pension pot, the greater the impact due to compound interest.
Options for employees
The first thing to do – perhaps confusingly, in light of the above – is to make sure you are opted into your workplace pension. Even if you are on a sub-optimal scheme, remember that your employer must pay at least 5% into it. This, effectively, amounts to “free money” for a pension; on top of the tax relief on contributions offered by the UK government (20% for Basic Rate taxpayers, and 40% for those on the Higher Rate).
Secondly, make sure you check the funds or “model portfolio” that your pension scheme is set to. Most likely, your scheme will offer three choices along the lines of “cautious”, “default” (or “balanced”) and “aggressive” (or “high risk”). Typically, employees are put onto the second option unless they actively change it. Whilst this may be suitable for some people, it is likely to be too cautious for many people – particularly younger workers with a long investment horizon before them. This can significantly limit the growth potential for your retirement savings.
Thirdly, check whether your scheme allows you to pick your own funds – rather than relying on one of the “pre-set” portfolios (which will likely select them for you). The problem with many of these portfolios is that the fund selection is not appropriate. For instance, perhaps the scheme puts too much of your money into one country rather than diversifying it across many countries. This can lead to missed investment opportunities. A financial adviser can help you check your fund choices and possibly construct a superior selection of funds from the scheme.
Finally, consider whether it may be worthwhile opening a private/personal pension alongside your workplace pension – such as a SIPP (self-invested personal pension). Many of the options in today’s marketplace offer a wider selection of funds with more competitive management fees – without compromising on quality or potential investment performance. It may be, for instance, that you could contribute the minimum 3% into your workplace pension (thus continuing to get the employer contributions) and put the rest of your retirement savings into your SIPP. Not only can you take this pension with you if you ever change jobs, but your money might go further in “real value” if you can achieve better returns at a lower cost.
Conclusion
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk