We believe more transparency is needed around objectives, making it clearer and easier for members to understand whether their pension arrangements are working towards the right outcome for them.
The inadequacy of DC pensions As the UK’s first generation of members wholly reliant on DC pension savings is approaching retirement, financial security will now be more in the spotlight. Recent Pensions and Lifetime Savings Association (PLSA) research showed 51% of savers are unlikely to meet the Pension Commission’s Target Replacement Rate (£19,162 p.a. for a median earner in 2017).1
Put simply, half of the population are not likely to have a sufficient DC pot to maintain their standard of living in retirement.
This places a greater importance on a Master Trust’s ability to solve the pensions inadequacy challenge; they have emerged as the DC vehicle of choice, growing in popularity, gaining ground over the last five years across FTSE 350 companies.2
Choosing the right Master Trust Several key elements form the decision on which Master Trust is the most appropriate. These include factors such as engagement tools, administration capability, member flexibility, charges, and investment strategy.
We have long argued that fundamental to DC is investment strategy: a key driver in whether people retire rich or poor.
The difference between the best and worst performing Master Trusts is 5.5% p.a. over 5 years to the year ending 31 March 2020.3 This is the difference between a pot of £115k at retirement and £350k (assuming this gap persisted over a 40 year career).
The difficulty in determining whether the right investment strategy has been chosen is exacerbated by delayed gratification; people are unlikely to know whether their employers have made the right choice of Master Trust for them until retirement – which is too late.
Master Trust objectives
At present each Master Trust states high-level investment objectives. But these objectives are largely the same: ‘aim to achieve better member outcomes’. Whilst this aspiration is perfectly reasonable, it lacks detail – how many Master Trusts would state they are not aiming to achieve member outcomes?
A small number of Master Trusts provide the required detail around their investment objectives and their Trustees work to deliver these objectives. But the majority don’t, meaning there is no accountability for the pension people receive at retirement.
A better way… learn from cost transparency
Through value-for-members exercises and transaction cost disclosures, there is now a vast amount of information available to members to better understand what costs they are exposed to.
Inevitably cost disclosures have continued to see a push to the bottom in terms of fees, with almost all of the Master Trust providers offering largely static passive investment solutions. In fact, the range of default charges across Master Trusts has fallen in recent years with the average sitting at 0.48%.4
A greater emphasis on objectives could therefore have the same impact on the industry; more clarity, and measurement of what the objectives are looking to achieve at a member level. A simple example is the projected pot requirements for the DC Chair’s Statement.
At present the projected pots just illustrate the impact of fees. There is no requirement to comment on whether pot sizes look reasonable or are in line with the objectives of the default provider, and subjective assumptions underlying the projections make it hard to compare projected pots among providers.
This is because the end goal is rarely the starting point for DC schemes.
Using a measurable target income level as a starting point can enable DC investment strategy objectives to be defined more clearly.
This will allow members and employers to determine and understand the success or failure of their pension arrangement in providing a good standard of living. The PLSA living standards, the Living Wage or The Pension Commission’s replacement ratios are all ways to help define the income needs of members and we believe that these should be explicitly embedded in Master Trust objectives.
Pension schemes exist to provide an income in retirement but that endgame is in danger of being lost. A greater emphasis should be placed on the income members need at retirement and how Master Trust default objectives help members to get there. Whilst the realised gratification for members may be delayed, this approach will help ensure there are no nasty surprises come retirement.
This article was featured in Pensions Aspects magazine September edition.
- “Hitting the target: A vision for retirement income adequacy” July 2018 - Pensions and Lifetime Savings Association.
- “FTSE 350 DC Pension Survey 2020: June 2020 – Willis Towers Watson
- Source: Capadata (performance as at 31 March 2020), R&M Solutions (calculations as at July 2020). Assumes 25 year old with starting salary £25,000
invested for 40 years with a contribution rate of 8%. Past performance is not a guide to future returns.
- “Charges, returns and transparency in DC: what we can learn from other countries?” December 2018, Pensions Policy Institute
Last update: 19 January 2021