The right default fund could have the same impact as doubling pension contributions

06 June 2019


New research is urging savers to monitor their pension fund performance as the wrong default fund could be delivering a low return. The right default fund however could have the same impact as doubling contributions.


The Tax Incentivised Savings Association (Tisa) has published new research showing that over the last three years, 20 of the largest pension provider's default funds delivered returns ranging from 3.4 per cent to 11.9 per cent. For someone on a £30,000 salary investing for 50 years, these two percentages could lead to a difference of more than £2 million in a final pension pot.


New research suggests pension fund performance is a significant factor when it comes to saving for retirement, especially as the pension pot increases in size over time. According to TISA, the investing and saving membership organisation, a 1% increase in investment fund performance is equivalent to a 3% increase in contributions over a 50-year period.  When you strip out the employer contribution, with minimum auto enrolment net employee contributions at 4%, this is equivalent to an individual almost doubling the minimum net amount they currently contribute.


The research also suggests that employees have significant potential to increase the long-term size of their pot depending on what pension scheme and default fund their employer chooses. Where schemes offer more flexibility, greater choice can also be made available to the saver.


Ninety five percent of members of defined contribution schemes are invested in the scheme’s default strategy which can vary hugely when it comes to performance.  Over the last three years, twenty of the largest pension providers’ default funds delivered returns ranging from 3.4% to 11.9%, which would have had an enormous impact of the value of savers’ pension pots.


To illustrate the impact of a performance uplift in monetary terms, if someone on a £30,000 salary invested in a pension fund with an annual growth rate of 3.4%, their fund would be valued at £153,600 after 50 years. Comparatively, if someone on the same salary invested in a pension scheme with an 11.9% annual growth rate, their fund would be valued at £2,271,200 over the same time period.


Renny Biggins, Retirement Policy Manager at TISA said:


“When it comes to choosing a pension scheme for employees, employers and financial advisers often focus on cost rather than other factors such as potential fund performance. Costs are transparent and comparable making savings easy to identify. Whilst a more sophisticated fund design doesn’t guarantee higher returns, the possible returns based on up to date modelling techniques should be factored into the decision making process to increase the likelihood of enhanced retirement outcomes for employees.


“Even a marginally better performing fund can make a huge difference to someone’s retirement savings, and it doesn’t have to come at a significantly greater cost. Most larger pension providers have enough headroom to change the makeup of their default funds without breaching the government’s default fund charge cap of 0.75%.


“Though mandatory contributions have gone a long way in helping people plan for their retirement – and we would like to see contributions increase further to 12% and possibly beyond through a phased strategic approach – contribution levels are only one half of the picture. Paying closer attention to the performance of scheme default funds is an essential part of ensuring employees are properly prepared for retirement. Additionally, if the aim of Auto Enrolment is to achieve appropriate financial resilience for employees and their families in retirement, it is unlikely to be achieved through contribution increases alone, which can be burdensome for smaller businesses and unaffordable for individuals.”  


Given the impact that investment performance has on the fund value over the longer-term and the discrepancy that exists between default propositions, TISA believes there needs to be more focus placed in this area.


Renny Biggins added:


“We would like to see providers, employers and financial advisers adopt a more holistic approach when selecting a default fund. Transparency of scheme default fund performance is key and whilst costs and charges are of course an important factor, the market is creating additional constraints over and above the charge cap with an over-emphasis placed on cost in isolation.”