Over Q1 as a whole, the Aon UK DC Tracker fell slightly, which suggests the expected future living standard in retirement provided by defined contribution (DC) savings was lower than at the end of the previous quarter. As usual, this overall decrease masks a more complex picture for the individual sample savers.
Older savers were the least impacted by this overall fall, as they benefited from higher-than-expected actual returns in early 2023 and were the least impacted by lower expected future returns.
As a reminder, in January 2023 the Pensions and Lifetime Savings Association (PLSA) released the latest inflation update of the Retirement Living Standards. The Q1 2023 release of the Aon UK DC Tracker showed that it fell significantly after being restated to reflect these updates, as shown on 30 September 2022.
Over the quarter (January to March 2023), the Aon UK DC Tracker fell from 69.7 to 67.9. This fall is almost entirely driven by reductions in future expected returns, meaning the sample savers’ savings are expected to produce a slightly lower income in retirement than at the previous quarter end.
The negative impact of this reduction in expected future returns was partially offset by strong benchmark investment returns over the quarter. This had a more pronounced impact on our older savers (who have built up larger current DC pots).
In contrast with previous quarters, the results suggest that our savers are, on average, expected to have a lower standard of living in retirement than was expected at the end of the previous quarter. However, it is noticeable that the movement over the first quarter of 2023 is much more muted than the significant shifts we saw during a highly volatile 2022.
Movement over the first quarter of the year
The decrease in the Aon UK DC Pension Tracker over the first quarter of 2023 was primarily driven by decreases in expected future asset returns for the different savers on the approach to retirement. To a degree, this was offset by slightly higher actual returns over the quarter.
All our savers, except for the oldest member, are now further away from a achieving the revised ‘comfortable’ level of retirement living standard than they were at the start of the year:
• The youngest saver experienced the largest fall in expected income of around £1,075 p.a. or
3.35 per cent. This was due to a decrease in expected future returns both over the period until retirement and when they start taking their benefits in retirement
• The 40-year-old saver saw a decrease in their expected retirement income of around £600 p.a., primarily driven by a reduction in expected future returns over the period until their retirement. This was offset slightly by the positive performance of their existing savings over the quarter.
• Savers closer to retirement also saw a reduction in the expected future returns over the period until retirement. However, the positive returns on their larger existing fund value meant the 50- year-old saver saw only a marginal fall over the quarter (of around £180 p.a.) when compared with the start of the quarter.
• The oldest saver was the only saver to see an increase in their expected income, albeit by a marginal amount (around £25 p.a.) as they are the closest to retirement and so are impacted the least by lower future expected returns, while also benefitting the most from investment returns over the period.
• Overall, the oldest saver is expected to be the worst off in retirement, with a retirement income around halfway between the updated minimum and moderate standards of living. This excludes any defined benefit pension benefits they may have but which are not included in this projection.
• The younger three savers are all currently expected to achieve an income well in excess of the moderate standard of living in retirement.
High inflation poses challenges for investment strategies
UK inflation reached the highest level in decades during 2022, and while this has begun to tail off in the first quarter of 2023, inflation is proving to be ‘stickier’ than first expected . This persistently high inflation poses challenges for DC savers’ investments, particularly for those in the run up to retirement.
While younger members are likely to have a significant investment in equities that over the long term should provide returns above inflation, older members are likely to have started moving towards more defensive assets (e.g. bonds) which may struggle to provide sufficient protection in the current inflationary environment. This is particularly important for members who are planning on taking a regular income in retirement, and who would hope to achieve returns in excess of price inflation to maintain their standard of living in the long run.
Many members will not have considered how they are invested or may not feel comfortable making their own investment decisions. They will therefore be invested in their scheme’s default strategy, where the trustees are responsible for setting the investment strategy.
Jo Sharples, chief investment officer, DC Solutions at Aon in the UK said: “There is a range of different investment strategies in the marketplace at the moment. In our own funds’ default strategy we take an outcomes-centred approach and favour a higher growth allocation heading into retirement. This reflects most members wishing to access their savings flexibly when they retire, and therefore remaining invested for many years. There will therefore be the need to deliver above inflation growth to maintain the purchasing power of investments as members start to withdraw their savings.”
Analysis has shown that different strategies have yielded significantly different returns over the past five years. The difference between the leading funds and those with lower returns could be as much as 22per cent over the five-year period*. Strategies maintaining a higher allocation to ‘growth’ assets, such as equities, throughout the ‘de-risking’ phase and into retirement have generally outperformed peers and provided members with greater inflation protection over the long term.
Alternatively, members could ensure their income keeps pace with inflation through the purchase of an inflation linked annuity. This would guarantee their income increases in line with price inflation each year, although it may come at a significant upfront cost.
Members who take all their benefits at retirement as cash may not only pay a significant tax charge but will also have to consider what they do with this withdrawal. At current inflation levels, leaving it in even the highest returning bank savings account would see the value reduce in real terms each year.
It is worth noting that one element of savers’ retirement income which is guaranteed to keep up with inflation is the state pension. This increases most years in line with the ‘triple lock’, rising in line with inflation, national average earnings, or 2.5 per cent, whichever is highest. The 10 per cent increase applied in April 2023 is likely to have come as a welcome boost to current pensioners.
*Source Corporate adviser intelligence Master Trust and GPP Defaults Report April 2023, 5-year annualised returns for saver five years to retirement
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