Given that we are now in a time with more people in defined contribution (DC) pensions than defined benefit (DB) pensions, it is essential that DC members understand where their pension money is invested and are comfortable that it matches their own pension aims, needs, risk tolerance and personal circumstances.
In a DC pension (when compared to a DB pension), there is a significant shift in responsibility and decision making from the employer to individual employees. In a DC pension employees need to decide how much they will contribute, changes to contributions over time, where their pension savings are invested and the need to change this, particularly in the 10 years leading up to retirement, as well as the choices they now have to make at retirement when accessing their pension.
Choosing the more suitable investment fund is complex. It not only requires a planning timeframe of what may be up to 60+ years - a significant challenge in itself - but it also requires an individual to understand the different types of investment, that they perform differently and the risk associated with those investments, their own attitude to risk and the role of risk when considering the period of investment.
Most people in the UK don't have this level of understanding and wouldn't know where to begin to make such decisions or even where to go to for further help.
The intention for a default fund is that it should provide a safety net which may be the most suitable investment for the majority of employees.
However, this is a huge ask. No two people will have the same financial needs, aims, circumstances and attitude to risk.
As a somewhat trite analogy and as we are coming up to Christmas, let's think of the Quality Street box. Each box contains the same number and mix of different sweets. But in households up and down the UK come Boxing Day, because everyone had a different preference, there will be little piles of pinks, greens or oranges left.
The default fund pulls together a mixture of different investment types designed for that particular employer and its employees. However, it will only ever be the most suitable choice for a proportion of employees, not all.
And taking that a step further, there are still a number of DC pensions that have not yet changed their default fund to reflect the wider choices now available under the pension freedoms, so the likelihood of these defaults being the most suitable for all employees is even more in question.
Every employee will need to review their pension investment choices when they begin saving, regularly throughout their career and certainly in the run down to retirement.
Financial education, the use of seminars, pension modellers and access to guidance and advice is the best way to ensure every single employee understands their choices and gives them the confidence to make the best decisions for them individually.
Without it, they will drift along in their career thinking that their employer will sort it all out for them and may not therefore make the best of their valuable workplace pension.
The majority (90%) of active defined contribution (DC) pension scheme members invest in their employer’s default pension fund, according to the Pensions and Lifetime Savings Association’s annual survey for 2015, published in December 2015. Default funds are designed for employees who do not want to make active investment decisions about their pension fund, which means that appointed trustee boards take responsibility for fund selection instead. But not all employees understand that this is the case. Michelle Cracknell, chief executive at the Pensions Advisory Service (TPAS), says: “We receive very few [employee] questions on investment decisions. In fact, some [employees] are not aware that their DC pension pot, or even drawdown product that they are thinking about buying, will be invested.”