• Investment growth is particularly valuable in the final 10 years of saving, and can account for 35% of overall pension savings.
• Prolonged de-risking in workplace default funds can significantly reduce a saver’s overall pot on retirement.
Around a third of total savings can come from returns in the last 10 years before retirement. Therefore, investors whose workplace scheme default fund de-risks over a longer time frame could be sleepwalking into lower returns.
Workplace scheme default funds are under scrutiny in the wake of Pension Freedoms legislation and the introduction of Independent Governance Committees. As the number of savers who buy an annuity plummets, most default funds – including Aegon’s – are expected to move away from strategies that aim to preserve the size of annuity to strategies that focus on risk reduction aiming to keep retirement income options open.
Automated de-risking in the run-up to retirement aims to cushion savers from the impact of a sharp market fall as they near retirement, and can be useful for default investors who don’t make active fund choices. However, this must be balanced against the resulting reduction in growth potential at this crucial pre-retirement stage.
Investment Director, Nick Dixon, said: “De-risking is about finding the right balance between reducing the impact of a fall and preserving some growth potential. As a saver approaches retirement their capacity to recover from investment losses reduces. However, this must be weighed against the dramatic increase in value that investment returns can add to a savers’ total pension pot in the final years of saving.
“Automated de-risking can offer valuable protection in the event of a market crash, and can be useful for default investors who don’t make active fund choices. However, lifestyle fund de-risking that lasts for more than 10 years can significantly reduce the size of a saver’s pension pot. That’s why our default fund options de-risk over periods of between five and seven years.”
Case study - Looking at a saver who started pension contributions of 8% a year at age 25, with a starting salary of £30,000 and post-inflation wage growth of 2% and assuming a constant 5% investment return.
On retirement at age 65, the saver would have a total pension pot of £406k. However, more than a third (£147k) is generated from investment growth in the final 10 years of saving. These late-savings investment returns are worth more than the investor’s total contributions over the life of their pension (£145k). The remaining £113k comes from investment returns over the first 30 years, when the total size of the savers’ pension pot was smaller.
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