By Mark Futcher, Partner and Head of DC at Barnett Waddingham
It is easy to think: “Why should I continue to invest in a savings vehicle that may be lower in value than it was last year?“ But as consultants we need to help members understand the issues and implications of potentially making poor decisions.
Investment returns
Particularly if we are invested in equities, many of us will have seen a drop in our fund value. However, members need to be reminded that a pension is a long-term savings vehicle and there will be short-term market volatility. As we have seen in the past, markets recover and go on to provide positive returns over the longer term. This is, of course, not guaranteed and we can’t predict when it will happen. But looking back over previous periods of market volatility shows us that markets do rebound.
Pension contributions
Pension membership provides a number of benefits and, as a member of an employer pension arrangement, it is not only our own contributions that are invested. Before any investment growth, we also benefit in the form of tax relief, as well as a contribution from our employer. Indeed, the level of pension contribution is the main driver behind having a good outcome in retirement, particularly for younger members.
If increasing contributions, it is always a good idea to consider the contribution structure applying. Many pension schemes are set up on a tiered basis and any increase to the level of employee contribution may also result in an increase in the level of employer contribution as well.
As we know, investment volatility will impact the price of investment units and, as markets fall in value, the price of an investment unit will also decease. Making contributions in a falling market can be advantageous and, rather than considering stopping of reducing contributions, it may be an opportune time for members to review their level of pension saving and consider increasing the amount of personal contributions.
By contributing on a regular basis, in a market downturn contributions can benefit from pound cost averaging. Whereby, if the price of an investment unit deceases as a result of investment conditions, the amount of units purchased is greater than before. The same also applies when making a lump sum contribution - it is always better to invest when the market is falling rather than waiting for the market to recover.
Many of us do have competing priorities for our money, even more so in the current environment. Pension saving can be flexible and, as well as increasing contributions, in some cases members may decide to reduce the level of pension contributions they are making or even stop contributing for a period of time. However the level of pension contribution should be regularly reviewed and we need to bear in mind that reducing contributions will have an impact on retirement planning.
Accessing pension benefits
The recent investment falls and job insecurities have prompted some members to consider accessing benefits earlier than originally planned. The freedoms and flexibilities certainly allow this and, if you are over 55, you can access some or all of your pot.
However, we need to stop and think and discuss with members whether this is the best course of action. If members are close to retirement and are invested in a lifestyle strategy and are de-risking as they approach their selected access age, this may not have much impact on the size of their pot and resulting income. However, for members primarily invested in equities, accessing benefits in a volatile investment market earlier than intended may well mean having to rely on a retirement income lower than before.
In these scenarios members may be better off delaying taking benefits or, if possible, waiting for markets to recover. If there is an immediate need, do all benefits have to be taken at once? Would it be more beneficial for some members to instead take advantage of the flexibilities that most DC products offer and start to access their benefits in stages?
Money Purchase Annual Allowance (MPAA)
Members who access benefits early, particularly for those who are some way from their selected access age and intend to carry on working and contributing into pensions, need to be made aware of the MPAA and the impact that this may have on future pension provision.
The rules can be complex and unclear. For example, many are often unaware that, if they take any income or further lump sum amounts above the tax free cash limit, future tax relievable total pension contributions will be limited to £4,000 per annum going forwards, rather than the regular Annual Allowance of the lower of £40,000 per annum or an individual’s total income. That’s a potential nasty shock for many pension members!
Pension scams
Even in the current environment we can forget there are still people out there trying to get us to part with our hard earned pension pots. We need to continue to make members aware of the risks of potentially transferring to unregulated products with promises of fantastic returns or early access, which can lead to losses of some or all of our pension funds. The old adage that “if it sounds too good to be true, it probably is” still remains true.
To conclude . . .
Although these issues have been primarily driven by the Covid-19 crises, it does highlight the importance for employers to engage with their employees. By doing so, whether it is a targeted communication strategy such as a newsletter or an email nudge, or simply pointing members in the direction of where they can find further information, it will help members better understand the features of DC pension saving and ultimately assist in improving member outcomes.
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