“Sometimes the questions are complicated and the answers are simple” (Dr.Seuss).
The author of The Cat in the Hat may not be the first name that comes to mind when you think of pensions commentators, but in this case he’s hit the nail on the head.
Employers, scheme members and the retirement industry tell us that pensions are complicated. We tie each other up in knots over miniscule points of detail. As a result, we sometimes make it difficult for members to engage – and in the process, deter them from building the best retirement fund that they can. But if you take a pension to pieces and simply view it as a long-term savings plan, you can quickly break down the barriers.
In essence, everyone with a pension needs to focus on building up the biggest possible savings pot, so that they will have the greatest flexibility and best available benefits when it comes to accessing that money in retirement.
So, if the complicated question is “how big can I make my fund?”, the simple answer is that there are just four elements to consider. All of them may be controlled, and both employers and employees have a part to play.
- Time. The longer you pay into a pension for, the better potential returns you will get.
What’s the problem? Encouraging people to start saving for a pension as early as possible is a challenge, particularly given all the other financial demands hitting younger workers.
How to fix it: Auto-enrolment has helped to alleviate the problem of starting early, and employers can further assist by offering good contribution structures and encouraging employees to see their pension as a genuine benefit.
- Contributions. A good rule of thumb is to start with a total (i.e. employer and employee combined) minimum contribution rate of 10% of salary, and contributions should double every five years.
What’s the problem? While auto-enrolment has been great at encouraging more people to save into a pension, the minimum contribution level is currently too low.
How to fix it: Minimum contribution levels will increase in 2018 and again in 2019. But even at that point the legal minimum of 8% (3% from the employer and 5% from the employee) will still be below that 10% starting point. But, good scheme communication can encourage staff to save more and techniques such as ‘save more tomorrow’, where employees commit in advance to increasing their contribution rates when they get pay rises, can also help.
- Performance and investment. The majority of pension scheme members won’t want to make active choices about how their pension contributions are invested, so a good quality default fund is critical. Monitoring the fund provider to make sure the default is fit for purpose and suits the scheme’s membership is one of the building blocks of good scheme management. However, there will be members of the workforce who want to make their own choices, so it’s important to offer some flexibility.
What's the problem? Default fund design has evolved significantly in recent years, so making sure that funds remain fit for purpose and are cost-efficient is important.
How to fix it: Initiatives such as the introduction of the charge cap for default funds in 2015 have helped to keep default funds affordable, while still allowing for innovation.
Most default funds are made up of a selection of different types of investment fund and offering access to the underlying ‘building blocks’ can give more informed investors flexibility to generate returns.
- Charges. Pension scheme charges are almost exclusively under the control of the employer. Businesses must carry out due diligence on their pension provider and negotiate fees downwards as appropriate. It’s also up to providers themselves to continually review their cost structure and how that relates to the charges they apply to schemes and members, as well as being as transparent as possible.
What’s the problem? If employers are not keeping an eye on their provider and negotiating effectively, members and businesses may end up paying more in charges than is necessary.
How to fix it: If providers are not being proactive about keeping charges low and reducing them whenever possible, employers need to consider reviewing their pension provider.
In the future, a fifth factor will become more important: flexibility. As over-55s get used to the idea of accessing their fund early, pension providers will need to be able to support them in making decisions on how and when to use their money.
Many members won’t know what they want to do until they get closer to retirement, so making sure that they have early access to advice, and enabling them to change their mind about their retirement plans will also be important. As Dr Seuss might have said, in order to get to the simple answers, you have to be given the chance to ask the complicated questions.
That’s all there is to it. These four (possibly five) interlinked factors give a simple, easy to understand approach to pensions that is under either the employers’ or employees’ control. Once you realise that, there is nothing to stop you from building the biggest possible pensions pot and enjoying the best possible retirement.
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