Need to know:
- Employers can offer a variety of fund choices through their pension scheme that can include high-risk and low-risk options for employees.
- Employees can use an online risk profiler tool to ascertain their appetite for risk, which can inform their investment strategy to ensure it suits their needs.
- Financial education can be a useful tool to help increase employees’ understanding around investments generally, although employer-provided financial advice may be more suitable for more financially literate staff.
Employee understanding around pensions, and in particular pensions investments, is still on relatively shaky ground. According to the Pensions with purpose research, published by Big Society Capital in February 2017, found that 40% of UK employees know little or nothing about their pension, while 41% do not feel well informed about where their pension contribution is invested. However, the research also found that employees do want to be engaged with their pensions investments, with 72% saying it is important to them to know where their money is invested.
So what can employers do to help staff better understand pensions investments and to empower employees to make active decisions around how their pension pot is invested?
Pensions investment optionsFor employees that choose to take an active role in their pension investment strategy, available fund options include low-risk funds that are typically invested in cash-based or bond assets, or high-risk funds, which are used to maximise returns. Employees are also usually able to invest in diversified growth funds. These offer investments across a wider variety of asset classes, such as in infrastructure, commodities and real estate, to produce a more guaranteed level of return with lower levels of volatility or impacts from market fluctuations. Those who want to invest ethically, meanwhile, can select funds to reflect this, while employees can choose a sharia fund if they have a religious objection to investing in certain types of companies or in funds that bear interest.
Default investment funds typically adopt a lifestyle approach which means that the investments chosen will adapt alongside an employee’s age in order to reflect their journey to retirement, explains Daniela Silcock, head of policy research at the Pensions Policy institute (PPI). "[Employees] have riskier investments when [they are] younger, and as they approach retirement, they're put into safer bonds and cash type investments," she explains.
The number of fund options an employer can offer its staff can vary greatly, says Sophie Ballard, senior DC relationship manager at State Street Global Advisors (SSGA). "We would suggest that the less choice [employees] have, then the more effective [it is]," she says. "I know schemes that have decided to have zero choice because they found that [employees] were actually damaging their pension pot by switching between different funds [because of] the transaction costs and the fees that were attached to those funds. And then I know schemes that have taken the approach that members should have as much choice as they want and could have up to 90 funds as a choice."
Between eight and 12 funds is the optimal number, says Ballard.
Outcomes of active decision makingEmployees may be able to generate a higher retirement income by making an active decision about their pension investments. “[The default fund is] one size fits all, but it doesn’t necessarily fit [an employee’s] circumstances, which is why we say that it would be better if people did make a choice based on their own risk profile, their own aspirations and how much they’re investing,” says Smith.
For example, if an employee is planning to stay in employment for longer than their lifestyle-based default fund predicts, or is planning a phased retirement, then they may have to adjust their pension investments to stay in the accumulation stage longer so they can continue to grow their pension pot while they remain in work.
However, active decision-making around pension investments might not be appropriate for all staff. “If it’s a brand-new saver who’s never joined a scheme before, particularly if they’re auto-enrolled, they’re probably unlikely to have very high levels of financial capability or very high levels of numeracy, so they may not have the capacity to understand very much about different investment options," says Silcock.
"Confronting them with an array of options […] can actually cause them to disengage, so I think [employers] need to be really, really careful.”
If employees are keen to make active investment decisions, employers should ensure they take action to help staff understand the potential risks of self-selecting funds, and inform employees that funds can fluctuate. “Make them aware that if they do choose their own investments, these can go up and down," says Ballard. "Employers need to make sure that if a member does choose their own investment, they’re aware of the risks.”
Employees that opt to remain in their pension scheme’s default fund can still count as making an active decision. Although not many schemes can measure which employees have chosen to be in the default through active decision-making or are remaining in the scheme through inertia, Some employees decide to stay in the default fund because they trust their employer’s investment choices, says Ballard. "It’s really about leveraging the trust that members have with their [organisation],” she explains.
Employer encouragementKate Smith, head of pensions at Aegon, adds: “Employers need to have a more active role in helping employees make better decisions.”
This can be done by using regular communication nudges as well as by promoting the available tools that can support employees in making investment decisions, such as risk profiler tools. This involves employees completing an online test to categorise their risk appetite. The profiler then limits the available fund options based on the employee’s specific results. "[Employees are] self-selecting the choices based on [their] risk profile," Smith explains.
An employee’s risk profile is not set throughout their lives; it can change depending on their personal circumstances, attitudes, other financial resources and their financial knowledge. With this in mind, employers should ensure they check in with employees approximately every 10 years to re-evaluate their attitude to risk, says Silcock. “Trying to set [pension investments] up when someone first joins a scheme is almost impossible because their approaches are going to change throughout their life," she adds. "A lot of this is really just trying to safeguard people pension investments against the future.”
Financial education can also be used in numerous ways to help employees before they make investment decisions, says Elliott Silk, head of commercial at Sanlam UK. For example, financial education that has been tailored for different life stages, such as for those who are five years from retirement, can help guide employees on how they can convert their savings into a retirement income. “Typically, five years away from retirement is around when [employees] need to be thinking about how [they’re going to] convert the money [they’ve] saved into an income, and also quite a lot of that education is around lifestyle, in as much as making sure [employees have] got hobbies,” says Silk.
Although targeted financial education can be a powerful tool for increasing the understanding of employees that are less financially aware, for those employees with higher financial understanding, personalised advice around specific objectives or products could be more valuable. Financial advice or adviser-led information for employees, either through one-to-one or group sessions, can work well for these members of staff. "The employer can pay per person for retirement advice but it's not a taxable benefit," says Silk. "The employer can offset it against corporation tax so there are some allowances out there for an employer to spend on [advice]."
Employers can also offer support to staff in making investment decisions with mid-life financial MOTs when they are in their 40s, and also by making use of pensions or savings champions within the business.
By providing guidance and information to encourage employees to be more proactive around their investments, therefore, employers can engage individuals with the freedom, if they wish, to tailor their investment options to suit their own circumstances and retirement desires.
