Vanilla default funds can smooth tricky pension problems, says Sonia Speedy
If you read nothing else, read this …
- Almost 90% of group personal pension and stakeholder scheme members end up in the default fund at some point.
- A default fund will never meet everyone’s needs all of the time.
- If well thought out, default funds provide a useful catch-all for employees who are not equipped to make their own pension investment decisions.
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Default funds in stakeholder pensions may not be the perfect solution to help employees build up an adequate pension pot, but they serve a valiant purpose and are worthy of employers’ attention.
The default fund is the automatic fund choice for a stakeholder pension if the employee cannot or won’t actively select investments themselves.
Default funds most commonly involve lifestyling. This means the employee’s pension pot will be moved into safer investments such as bonds and cash as they near retirement, having been in more volatile investments that theoretically deliver potentially higher returns like equities.
Scottish Life head of corporate business Mark Polson says almost 90% of stakeholder and group personal pension scheme members will end up in the default fund at some point, making it essential that employers make the best possible selection.
The main advantage of default options is that people who are not equipped to make an active investment choice can go into something that should be generally suitable.
“There’s a danger if you don’t have a default fund, that somebody who has say two years to go to retirement and has moved into the scheme ticks the default box and that’s not really appropriate for them,” warns Polson.
But default funds also have their negative side. Kevin Wesbroom, senior consultant at Hewitt, says: “The biggest problem with defaults is the fact that individuals don’t ever actually engage in the process and the biggest threat is that they don’t really start to take the whole process seriously enough.”
This lack of understanding can also have another potential downside in that angry uninformed employees may come back to blame the employer later on if something goes wrong.
Likewise, staff may assume that considerable time and effort has gone into choosing a suitable default fund. However, if this is not the case they can be left exposed. Defaults are also a one-size-fits all solution, that will never suit everyone all of the time, as employees will all be at different life stages, with varying lifestyles and financial situations. Roland Jones, senior pensions consultant at Towry Law, says. “[They are] like the Ford Model T. You can have any colour you like as long as it’s black.”
While default fund providers now tend to offer a range of funds with some variance between them, experts say that in reality what is on offer is largely vanilla.
To help employees understand them, JPMorgan Invest director Jonathan Watts-Lay says employers need to provide basic education and not just passive information on their stakeholder pension. He believes this should involve “getting people in a room” to provide generic education on things like the size of the pension pot needed to generate a reasonable retirement income.
Meanwhile, Polson believes it is the duty of the provider and the employer’s advisers to ensure that specific default fund information is available, readily digestible and offers the technical details that those wanting a greater depth of information may need.
Employers can then help provide professional financial advice, or point employees in the right direction for it.
Jones sums up default funds nicely. “I think the idea of default funds is a reasonable one. It’s the kind of least-worst solution to a tricky problem.”