With further calls on the government to encourage a greater engagement in individual retirement provision and now over 10 million employees enrolled in a DC pension plan, the suitability of these pension arrangements and the importance of the individuals taking an active role in managing their retirement provision has never been more important.
The good news is that markets have bounced back following the crash at the beginning of the pandemic and some portfolios are now in a position where they are seeing a growth from their pre-pandemic levels. With a post-pandemic world seemingly getting closer it looks like long-term impact on the majority of DC pension savings of this volatile period will not be as bad as first feared.
However, with economic growth expectations on the decline, debate about whether the current minimum contribution levels are sufficient will surely take greater prominence.
Over the last 15 years, and with the commonly sourced reason of a shift towards a slower but longer-term growth environment, future return expectations have plummeted. The FCA publish periodic reviews into its assumptions surrounding investment growth and over the period from 2007 to 2017 these show a decline of between 1.5% and 2.6% per annum in the expected return across the main asset classes commonly used for DC pension provision.
With investment growth expected to make up a significant part of each member’s final DC pot, the decline in the expectation of future growth is obviously concerning for members of DC pension plans. As expected growth is now significantly less than when the 8% minimum contribution rate was introduced, serious consideration now needs to be given to increasing the amount of minimum pension contributions that members and employers need to make.
The analysis set out in ‘Is 12 per cent the new 8 per cent?’ published by LCP and Interactive Investor leads us to the strappy headline figure that contributions would need to increase by 50% to provide the same level of DC benefit when comparing the FCA’s 2007 and 2017 assumptions for future growth.
The table below summarises some of the analysis for a 22-year-old investing into a generic DC pension plan over their working life up to age 65.
As a rough guide this £85k might translate into an annual income of £2k to £3k based upon current annuity rates.
This difference is only indicative of the illustrative example used. The required increase will vary significantly from individual to individual, but it does give an idea of the scale of this issue.
With contribution levels for DB provision generally being significantly more costly (at an average of around 25%) and members taking on most of the risks associated with DC pension plans, there is clear disparity with what used to be considered the norm. The counter argument by some is that the cost of DB pensions was overly generous and unsustainable, notwithstanding it is an entirely different beast, so it is at best questionable as to whether this is an appropriate barometer for setting a new minimum contribution level for DC pension schemes.
With lower expectations of future growth, the value of DC contributions has been diminished. Whilst the current minimum contribution requirements clearly fall short of that required for a comfortable retirement, they do at least provide a platform for individuals to start saving for their retirement which can only be a good thing.
Like many in the industry we would encourage the government to review the current minimum contribution requirements for DC schemes and to identify ways in which they can be improved so as to deliver better retirement outcomes for millions of savers.
Peter Duvall, Consultant (Actuarial) . Quantum Advisory
