The 6th April 2018 saw the first round of ‘auto escalation’, the increase of minimum employer and employee pension contributions under auto enrolment. However, whilst greater retirement savings are to be universally encouraged, the benefits of the increase will be eroded significantly if it is not accompanied by a review of the default investment strategy of a DC pension scheme.
Our research indicates that the losses incurred from being in a poor-quality default fund negate the progress made by increasing contributions for a saver starting from scratch.
The projected value of savings for a 22-year-old starting to save into a pension with 5% contributions using a poor-quality default fund is almost identical at age 55 if that person continued on the current 2% contributions and chose the best available default fund.
If scheme trustees and sponsors take care to choose a best performing investment arrangement, the outcomes for savers could be exactly the same without having to reduce their take home pay. The importance of choosing a good quality default strategy cannot be overestimated.
When auto escalation is implemented for schemes with strong investment governance arrangements, the combined effect of increased contributions and increased investment returns can create truly impressive results. The table below helps illustrate this:
JLT has made the above calculations based on the following assumptions:
- Max is in his early twenties and earns £22,000 per year. He is just starting to save into a pension with work.
- He is just starting to save into a pension and both he and his employer are only making minimum AE contributions of 2%, which will (or will not) increase in line with auto escalation.
- Although he has no pension savings yet, he has many years ahead of him to work and save.
- Max has an annual salary growth of 1%; the values are calculated at age 55; the fees are 0.75% per annum.
To find out how to ensure your default fund is giving your Defined Contribution pension scheme members the best opportunity to reach their retirement goals, contact your usual JLT Consultant or Maria Nazarova-Doyle, Head of DC Investment Consulting, firstname.lastname@example.org.