In the wake of the UK pensions shake-up, savers have a myriad of questions to ask. How much should they pay into a scheme and for how long, what should they do with their money when they get it and, more importantly, how are their pension savings being invested?
Pension reform has prompted companies such as Standard Life to develop flexible, future-proof investment solutions that give savers more choice and a better chance of achieving their desired retirement outcome.
The introduction of auto-enrolment means an increasing number of people are now in investment solutions, through their workplace pension, that they have not actively chosen – a default investment. This places greater responsibility on providers of workplace pensions to offer truly “hands-off” default investment solutions that meet the needs of customers, not just at the outset but on a continuing basis.
In spite of the detailed media coverage around pensions and the recent changes, people still find it a complex subject that is difficult to understand. “There are people paying into pension schemes who don’t actually realise their money is being invested,” says Jenny Holt, head of investment solutions at Standard Life. “And even those who do and who are in a default solution want others to take action on their behalf if things change.”
Up until April this year, most people bought an annuity with their pension pots and most default investments were designed to reflect this. Now people have more choice about how to take their money and default investment strategies need to change accordingly.
This is where a more modern approach to default solutions can really come into play.
It is through the active management skills of Standard Life Investments that we have been able to deliver strong investment performance after charges
“Most default investment options that employers offer are lifestyling profiles or target-date funds, designed to derisk as investors approach their retirement,” explains Ms Holt. “Our solutions combine the best of the two approaches. They have future-proofing built into the structure, which has allowed us to update the investment mix of our default solutions to reflect the fact that our customers can now access their money in a variety of different ways.
“We’ve also launched new solutions that target specific outcomes for those who do know what they want to do. Importantly many of these new solutions keep customers in diversified asset mixes as they approach retirement and provide consistency of approach both ‘to and through’ retirement so those who wish to take a flexible income don’t have to change their investment mix at that point.”
Another key aspect of a modern default strategy, according to Standard Life, is active management.
Active fund managers carry out extensive research before selecting the assets they think will perform well in the future. They aim to beat some particular market or benchmark, after fees have been deducted, for a particular level of risk, while passive investment funds will try to match the performance of the benchmark, rather than better it.
“It is through the active management skills of Standard Life Investments that we have been able to deliver strong investment performance after charges,” says Ms Holt. “Standard Life Investments changes the mix of investments between asset classes over time to deliver investors the best possible return at a level of risk they’re comfortable with, recognising that for many people there needs to be an element of trade-off between people’s attitude to investment risk and the need to take risk to generate returns.
“This approach also benefits employers as it creates a smoother journey for their employees and improves the consistency of outcomes between different generations of workers.”
Passive fund charges tend to be lower than those associated with active funds and opinions remain divided over which investment strategy is the most effective. But, as Ms Holt points out, investors should be looking beyond costs and focusing on better outcomes.
Standard Life always makes clear that all investments, whether passively or actively managed, can go up or down and past performance is not a guide to future performance. From their own solutions in the workplace market, they report that their actively managed default solutions have, after charges, outperformed more passively managed equivalent solutions every year since their launch. In practice, both active and passive investment strategies have a role to play.
Even with a good default investment solution in place, if people are not offered the support and guidance they need to feel confident about making decisions at the right time, there is the risk of further disengagement and inertia. And following the new pension freedoms in April, people may end up making poor decisions, which could impact on their financial security in retirement.
The decisions that Standard Life’s customers have been making about their retirement savings six months after the new freedoms and flexibilities were introduced suggests most people are taking a cautious approach.
Only 6 per cent of Standard Life’s eligible customers had made use of the new pension freedoms since April 6, leaving the vast majority choosing not to touch their pension pots and stay invested.
The findings also debunk early predictions of those reaching the age of 55 hastily cashing in their pots, incurring a significant tax bill in the process and leaving themselves penniless at retirement.
This is encouraging, but if people are to get the best out of their pensions in the future, they will need to become more involved in monitoring and reviewing them.
Some people lack an appetite for making any proactive choices about their investments, and here an effective communication and engagement approach can improve outcomes.
It can help people understand the role that investing plays in pension saving and how the default solution actually works. They can then decide if it is right for them and, if so, how frequently they should be checking their investments and reassessing their retirement goals.
“A range of different communication approaches is likely to be most effective and we need to be engaging with customers over a period of time, not just in the six months before they come to retire,” says Ms Holt.
“We want to steer customers away from making bad decisions by making sure they have the information they need to understand their pension investment and have the confidence to make decisions based on how they want to take their income. By encouraging active decision-making, and combining this with both active oversight and good active investment management, providers can help customers achieve their retirement goals.”