Pension values down 25%
Workers saving into defined contribution pension schemes have seen the value of their nest-eggs plummet by an estimated 25% since the credit crunch hit.
New research shows that the collective value of assets held in defined contribution pensions stood at around £550 billion in September 2007. However, following 16 months of stockmarket chaos, interest rate cuts and the onset of recession, the value has dived by around 25%, standing at £410 billion by the end of January 2009.
Defined contribution pensions, where both you and your employer pay a fixed contribution into the account, tend to be heavily invested in equities until shortly before retirement. At this point, the investments are normally swapped for less risky assets such as bonds and cash.
However, for most of its life, the value of a defined contribution pensions will closely track the value of the stockmarket. The massive falls seen across stockmarkets can be highly damaging for workers with defined contribution pensions. But the impact on you will largely depend on your age and how far off retirement is.
Helen Dowsey, principal at Aon Consulting, which carried out the research, estimates that a 60-year-old planning to retire in five years will have seen their projected pension value fall in value by 36%. In comparison, a 30-year-old will only have suffered an 8.5% fall in their projected pension value as they still have time to recoup the losses made in the past year.
Dowsey adds that workers must review their defined contribution pensions on an annual basis to ensure it is performing as well as possible: “There is a widely held misperception, perhaps borne out of discussions around final salary pension schemes, that pension values are guaranteed.
“In reality, the level of contributions paid in, the real investment return received and the annuity rates prevalent at retirement, all affect defined contribution pension accounts.”
What should you do?
If you are approaching retirement (55-65 years old)
If you haven’t switched your pension away from equities and into “safer” options, then the bad news is that the fall in pension assets could see you retire with a smaller pension pot than you originally expected. The best way to maximise your retirement income is to ensure you shop around for an annuity, rather than just taking the product offered to you by your pension provider.
The Financial Services Authority (FSA) estimates that the difference between the best-paying annuity and the worst can be as much as 20% - so it really does pay to shop around. You can compare annuity deals on the FSA’s independent comparison tables.
If retirement is on the horizon (40-55 years old)
Aon Consulting estimates that your pension could have fallen by between 20% and 30% since September 2007. It recommends that people in this age bracket review their pension as soon as possible and decide whether now is the time to adopt a lower risk profile.
“It is not too late to think about the target age of retirement and the strategy of gradually switching automatically out of equities and into cash and bonds over a period of time, say, seven years,” advises Dowsey.
If retirement is still a way off (18 – 40 years old)
This age group is the least affected by the fall in pension asset values, as over time the falls should be levelled out by rises. Your best option is to continue to review your pension regularly to ensure it is invested in asset classes that are likely to deliver the best return over the longer-term.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).