Auto-enrolment means millions more workers now have pensions – but are they any good? We look at what you can do to improve your options.
Since auto-enrolment began in 2012 over 10 million more workers have saved into a pension. But how good are these workplace pensions and what are your options to tailor them to your individual and changing needs?
Find out what type of pension you have
If you have been auto-enrolled, it is very likely you have a defined contribution (DC) pension. This means that both you and your employer contribute to your pot. The size of your pension pot in retirement will be determined by how much you and your employer have put into it over the course of your working life, as well as how well the investments have performed. Your contributions are normally taken directly from your salary before it is taxed.
The other type of pension is defined benefit (DB). This gives you a guaranteed pension income that is not dependent on how much you have put in or investment performance. This older type of scheme is particularly generous as employees don't have to worry about market performance - the employer carries all the risk. As a result, few employers now offer this type.
You can read more about the different types of workplace pensions and how they work in our guide here.
Your employer may have its own company pension scheme, which it manages itself. Alternatively, it may use a master trust, in which multiple employers pool their assets and resources in one place. In master trusts, each employer has its own division but there is only one board of directors, which allows employers to manage a pension scheme with lower costs and simpler governance.
According to The Pensions Regulator (TPR), the number of people whose pension is saved in a master trust has risen from 270,000 in 2012 to 16 million today – nearly two-thirds of all UK workers (60%).
Find out how your pension is invested
All pensions are invested in financial markets - it is highly unlikely that any of your pension is sitting in cash.
Most pension providers offer you a choice of different funds or groups of funds to invest in. However, the vast majority of pension savers do not actively choose where to invest and so their money is put into a default fund.
It is a good idea to find out how your money is invested, to ensure it is not languishing in an unsuitable fund.
The default fund will be one-size-fits-all, so will not necessarily take into account your personal circumstances, for example, when you hope to retire, whether you wish to invest ethically, or how much risk you are comfortable taking with your investments.
Staying in a default fund that does not suit your needs could cost you tens of thousands of pounds in retirement, so it is worth checking and moving if you are not happy.
Michelle Gribbin, chief investment officer of Profile Pensions, says: “When it comes to planning for retirement, many people aren’t aware that they should regularly review and compare their pensions to ensure they’re getting a good deal.
There are several different things to consider when deciding whether you have a good pension, including charges, investment choice and how you can access your savings."
The default fund that most employees are placed in typically invests around two-thirds of your money in the stock market and uses a ‘glide path’ as you approach retirement, progressively moving your money into safer asset classes. This style of fund is often called a lifestyle fund.
This system used to work well in the days when most people bought an annuity with their pension pot upon retirement. The logic was that that last thing you want just before cashing in your pension pot is a big market crash that slashes its value. However, these days few people buy an annuity and many keep their pension pots invested well into retirement. Furthermore many people are now working well past the typical retirement age and so will not be spending from their pensions until much later. Therefore it may not make sense to reduce your stock market exposure - and therefore your chance of higher returns - just because you are reaching state retirement age.
Nathan Long, senior pension analyst at Hargreaves Lansdown, explains: “Default funds are a necessary element of auto-enrolment pensions but, by their nature, they are designed to be a conservative one-size-fits-all solution. For most people, better investment options are available.”
Patrick Connolly, certified financial planner at Chase de Vere, adds: “Traditional lifestyle fund approaches can fall short where people retire at different ages, go into phased retirement or want to use the pension freedoms and take their pension benefits in different ways rather than just buying an annuity.
“Younger pension investors can afford a higher degree of investment risk in the hope of better returns.
“The bigger challenge comes as people get older, because the right strategy will depend on how and when they take their pension benefits.
"Your pension provider might have limited investment options, other funds could be more expensive and, of course, you might make the wrong choices, which would impact on the size of your pension fund.”
Find out what investment choice you have
You may find that your pension provider's default fund is fine for you. However, if not, you will want to be sure that there are suitable alternatives that suit your needs.
Some company pensions allow their employees to invest in a wide range of funds, while others offer a very limited selection or no choice at all.
It is a similar story with master trusts, where the five largest schemes account for more than 10 million members and 781,422 employers and manage in excess of £30 billion. The five providers are: NEST Pensions, L&G, LifeSight, Standard Life and Mercer.
See the table (below) for a breakdown of how the five master trusts compare.
NEST is the veritable goliath of master trusts. Set up by the government to lead the charge on auto-enrolling the workforce, more than 90% of NEST’s 8.5 million members are auto-enrolled.
The master trust’s investment strategy aims to be easy to follow, with a selection of seven types of strategy to pick from: default growth, higher risk, ethical, lower growth, Sharia compliant, pre-retirement and guided retirement.
NEST says that despite this choice, more than 90% of its members are in the default fund option, its retirement date fund.
This fund invests largely in shares until ten years before the member's expected retirement date. At this point the member's money is gradually moved into safer investments so that by the time they reach retirement age their portfolio is at little risk of market volatility.
However, as risk levels are gradually curbed, so is the opportunity of higher stock market returns.
NEST charges a fee of 1.8% on all cash put into your pension pot, and also takes a fee of 0.3% of the total value of your retirement fund every year.
Legal & General
Legal & General’s master trust is another colossus – more than one million people have a retirement pot with the firm, totalling a cool £8.8 billion.
Members are automatically placed into its default L&G Multi Asset PMC Pn 3 fund, but can move.
The default fund has no sign-up charge, and its yearly fees range from 0.13% to 0.5% of your retirement pot depending on how much you have invested.
L&G’s members have a choice of 16 other funds if the default option does not suit.
LifeSight is the most diverse master trust in the top five, and offers its members the most choices about how they invest their retirement money.
It has nine standard options for those preparing for retirement. Members decide whether will they want to take their pension cash as a lump sum, buy an annuity or use drawdown, then pick one of three risk levels for each – low, medium and high.
If members do not specify otherwise they are put in the default option, the Medium Risk Drawdown Lifecycle fund.
LifeSight also has 22 other funds if the other nine are unsuitable.
Fees vary depending on which you pick, but range between 0.24% and 0.29% for the nine default options.
Standard Life has one of the oldest master trusts, launched in 1974 and long predating auto-enrolment.
But it is not just old, and big – it is also diverse. There are six default funds, split into active or passive and then subdivided by risk, and then 18 additional ones.
Standard Life says it aims to give its members a wide range of passive and active investment options across all major asset classes.
Fees range from 0.07% a year to 1.68%, and transaction charges can also apply.
The good news for those wanting ethical investments is that many of the master trust’s funds do this as standard.
A Standard Life statement says that “consideration of ESG factors is already part of the investment strategy adopted within the actively managed funds, including those within the core default strategies”.
The default option for pensioners are Mercer’s three SmartPath options.
SmartPath Target Drawdown is suitable for those who want to draw an income from their pension pot. SmartPath Target Annuity is for those who want to buy an annuity and SmartPath Target Cash is aimed at people who want to take their pension as a cash lump sum.
All three invest in higher-risk areas until you are eight years from retirement, when they gradually switch to lower-risk funds.
If you do not make a decision then you are automatically given Mercer's Target Drawdown deal.
All three default options charge 0.22% a year until you are eight years from retiring, when fees begin to vary depending on your selection.
Alternatively you can pick from 19 other Mercer funds, including Shariah and ethical options.
Watch out for fees
Fees can seriously erode your pension pot. A percentage point here or there could amount to tens or even hundreds of thousands of pounds over time.
You may pay fees both to your pension provider and for each fund that you choose so keep an eye on both.
If you do not think you are getting good value, you could switch funds or switch provider. However, make sure you do your homework before switching. If you have an old-style defined benefit scheme, it may well come with valuable guarantees that you would not want to give up.
Moira O’Neill, Head of Personal Finance, interactive investor (Moneywise's parent company), says: "Many of us will have accumulated several pensions over the years. It can be easy to lose track of them and sometimes those older plans may no longer be the best option or represent good value for money. That’s why there’s a strong argument in favour of bringing your different pensions together under one roof, whatever stage of the investing journey you’re at.
"Consolidating your pensions in the one place makes them easier to monitor and manage, reduces hassle and paperwork and helps you identify the pension investments that aren’t working, or which look more expensive than they need to be.
"That last point is often the one to nudge people thinking about gathering their pensions in one place to take action, especially in a time of low interest rates and limited investment growth. One reason for that is the potential to make savings, particularly if you have one or more older pension plans.
"However, it’s important to sound a note of caution here as, even when such savings are on offer, consolidating pensions might not be the right thing to do for everyone. It’s a decision which requires careful thought and consideration of what you might be giving up as well as what you could gain. That’s often because of protected or safeguarded benefits. For instance, many pensions taken out prior to April 2006 include an option to take more than 25% as a tax-free cash lump sum, while certain older plans may come with guaranteed annuity rates (GARs) that promise income considerably higher than that available on the annuity market.
"Defined benefit plans pay a pension equivalent to a proportion of your salary, based on how long you worked for that employer. That pension is guaranteed and if you move it to a defined contribution plan, like the ii SIPP, you’d be giving up that guarantee and may not be able to secure the same level of income. That’s why the industry regulator (The Financial Conduct Authority) insists on you seeking professional financial advice if you’re thinking of transferring any safeguarded benefits worth more than £30,000.
"Certain workplace pensions will also have additional benefits which would be costly to replace, while some older pension plans may have very high exit charges which could cancel out any potential gains. You may also lose investment value or potential future bonuses if you’re invested in a with-profits fund and transfer out before the agreed maturity date. For the vast majority of those holding one or more older pension plans, however, the idea of upgrading them into a lower cost, more flexible and manageable pot is one worth considering."
Make sure you are taking on the right level of risk
On the face of it, taking risk with a pension can sound reckless and cavalier. Intuition may suggest that when investing the pot you will need to live on for the remainder of your life, you should act cautiously. However, this is often not the case.
As a rule of thumb, when investing the greater risk you take on the greater the chance of higher returns. For someone young with decades of work ahead of them, taking on a lot of investment risk can be very prudent - they have the opportunity to grow their money as much as possible and time to ride out any large market falls.
Someone moving closer to retirement may want to take on less risk to reduce the chance of suffering large falls in the value of their pensions just before they need it.
Since pension freedoms were introduced in 2015, retirees have been able to keep all or some of their pension invested after they have stopped work. This could mean that they could continue to take some investment risk, even though they have retired.
Many pension providers will ask how much risk you are happy taking to determine which fund to put your money into. When answering this question, it's worth remembering that not all risk is necessarily bad.
What if your pension does not offer you the choice you need?
If your pension is not good enough, you could consider transferring to an alternative. Self-invested personal pensions (Sipps) can be a good option. These tend to offer a wide range of investment options and many are competitively priced.
However, be careful if you are considering switching a workplace pension that you are investing in through your current employer. The last thing you want to do it turn off valuable employer contributions by moving out of your current employer's scheme.
Mr Long explains: "Some pension providers will allow you to transfer part of the money you have built up into a Sipp as long as you leave some of your pension to keep receiving contributions.
“Whether you have an old workplace pension or one through your current employer, you should check any penalties to transfer. Most modern plans do not have these, but it pays to be careful.”
If in doubt, discuss your options with an independent financial adviser.
If you are unable to switch out of a workplace pension, but feel it does not meet your needs, speak to your employer. Let them know if the provider it is using does not offer the variety or types of funds that you would like, for example, ethical or shariah-compliant funds, or if its charges are not competitive. By engaging more with our pensions and asking more questions, we are likely to get a better deal for ourselves and our colleagues.
Note: all figures correct as of 2 June 2020.
|Pension master trust provider||Employees enrolled||Number of employers||Assets managed||Other funds members could switch to|
|NEST Pensions||8.5 million||720,000||£9.9 billion||6|
|Legal & General||
|Standard Life||226,293||1,231||£4.3 billion||18|
How much do I need to contribute?
The minimum amount employees pay under auto-enrolment is capped at 5%, up from 3% in April 2019.
Your employer normally contributes 3%, making your pension 8% of your income a year.
If your employer pays more than 3% then you can contribute less than 5% if you wish, provided the total is still 8%.
You can read more about auto-enrolment and how to make sure your pension stretches to the retirement you want in our ultimate guide here.