Need to know:
- Some employees have experienced sharp losses which have derailed their retirement plans.
- Many very low risk default funds have lost money as gilts plummeted.
- Unfortunate timing of the stock market falls in March will be starkly reflected in annual statements.
- Covid-19 (Coronavirus) has created a perfect storm for poor decisions by employees, such as raiding their pension pots prematurely.
While the Covid-19 (Coronavirus) pandemic has not introduced new risks for defined contribution (DC) pensions, it has massively increased a number of existing ones. The UK stock market fell 24% in the first half of 2020 and while younger employees’ investments should recover over time, some of those coming up to retirement are facing sharp losses.
Research by Fidelity and Aegon suggests many employees whose pensions have been hit by the Coronavirus pandemic will delay retirement. Aegon’s Retirement readiness survey, published in June 2020, suggests one in five of the population will keep on working, while Fidelity’s Investor survey, also published in June 2020, reveals that three-quarters of investors due to retire in the next five years are rethinking their plans.
Default fund performance
Many default funds seem to have performed quite well, typically rising by around 4% to 6% in the year to June 2020, and almost all are in positive territory over 12 months, according to Nathan Long, senior analyst at Hargreaves Lansdown.
However, the market falls in March 2020 were the first real stress test following both the redesign of many default funds, and also indeed the introduction of the pension freedoms of 2015. Brian Henderson, UK head of Mercer’s DC and savings team, says: “Given the trend in DC towards multi-asset strategies in default arrangements, DC governing boards should examine how their diversified funds have performed during the recent falls and whether they have behaved as expected.”
For schemes whose members are expected to take their pension pots as cash or buy an annuity, low-risk strategies are usually implemented in the years prior to retirement. Many of these strategies have produced flat returns over 2020 to date, which translate into negative returns after fees. Schemes should, therefore, review these strategies and the fees paid on cash funds.
Tom Selby, senior analyst at AJ Bell, says: “There were many cases of annuity-targeting funds suffering double-digit drops as the UK entered lockdown. This was because gilt investments plummeted in value, leaving some facing the prospect of retiring on a lot less than they expected if they cashed in at the wrong time. As lockdown is eased, serious questions should be asked about the extent to which gilt investments are suitable for someone who wants little to no risk in their portfolio.”
Employee communication
Communications should focus on education and reassurance in easy-to-understand language to prevent employees making panicked decisions they may later regret. Caroline Escott, senior policy lead, investment and stewardship, at the Pensions and Lifetime Savings Association (PLSA), says: "The PLSA recommends that schemes discuss with their advisers the medium-term impact of Covid-19 on different groups of members and what can be done in terms of communications and support with retirement planning to ensure that members make the most appropriate choices.”
If annual benefit statements are due, it is worth supplementing the provider’s message, particularly as the market hit a low point in the last week of March. Rona Train, a partner at Hymans Robertson, says: “Most schemes have either a 31 March or 5 April year end so valuations on annual benefit statements for many will be low, so some additional communication in addition to the standard information given by administrators to provide re-assurance should be considered.”
Targeted communication signposting employees to support and guidance may also help them swerve uninformed decisions that can lead to poor outcomes, such as selecting inappropriate investment funds, raiding their pension pots prematurely, succumbing to scams or inadvertently breaking the regulations.
Martin Willis, principal at Barnett Waddingham, says: “Covid-19 has created a perfect storm for this. Members may wish to draw benefits earlier than intended due to wider financial concerns, and stock market volatility has significantly reduced fund values. This creates a double whammy of using up funds intended for retirement and realising significant losses before any de-risking can take effect. Another unintended consequence is members triggering the money purchase annual allowance (MPAA), cashing in pension pots to cover short-term income requirements.”
Contribution increases
For members with years of working life left, schemes might consider staggered annual increases in contributions to catch up on any Covid-19 shortfalls.
It may also be timely to take into account the employer’s environmental, social and corporate governance (ESG) and climate risk policies in the design of investment funds.“One thing to come out of the pandemic is the way in which [employers] have reacted, some being a force for good, for example, shifting production to hand sanitisers, and others treating customers and staff less well,” says Train. “There is likely to be an increasing focus on where a member’s pension is invested and this is a great opportunity to be re-examining both how our pension schemes are invested in relation to responsible investment and to share good news stories with members on how investment managers are using their money to influence [organisations# on the way they act.”
In the immediate future, schemes should also be making sure processes are correct in regard to employer duties, auto-enrolment and safeguarding mechanisms for members. The Coronavirus Job Retention Scheme (CJRS) was thrust on employers with little time for digestion, and working out what should be paid to pension schemes, especially where salary sacrifice is used, was initially unclear, and even now is complicated.
