Workers warned off ‘safe’ pensions

by Alice Ross

Pension consultants have warned that employees may be choosing the wrong funds in their companies’ pension schemes, putting their retirement income at risk.

Four in five workers at most UK defined contribution pension schemes now pay into their company’s “default” pension fund, according to research by Aon Consulting. Inflows into default funds have been rising, which Aon says is likely to be due
to workers seeking the “safe” option, after many pension funds lost up to a third of their value last year.

But these funds may not be as safe as employees believe.

“Employees think that because the employer has selected the default fund it’s a safe option and not subject to capital risk – the reality is very different,” warns Helen Dowsey, a pensions consultant at Aon.

“For an investor who is particularly cautious, it can be a shock to find the value of their fund has fallen by a third.”

Companies’ defined contribution pension schemes usually offer a range of funds. These can include funds in cash, fixed interest, property or equities.

Employees who fail to select a fund are automatically put into the scheme’s default fund. This is often a global equity index tracker fund, which could carry more risk than many employees want to take.

Under a defined contribution arrangement, employers and employees both contribute to a pension fund, but the employee bears the risk of the fund falling in value. These schemes have been replacing final-salary schemes, where the employer bears the risk.

But there is a lack of awareness of the different forms of risk in a workplace pension scheme, consultants say. A cash fund may pose little or no capital risk, but it will not protect a pension fund against inflation over the longer term.

“Members think of risk in terms of capital risk but not in terms of inflation risk or opportunity cost risk – which is the risk of going for the safe option and missing out on the long- term gains,” said Dowsey.

People about to retire are also faced with a difficult balancing act when deciding when to purchase an annuity with their pension.

The value of pension funds has been falling, but annuity rates are also moving down as people live longer – so people who delay buying an annuity might not receive a higher income if the value of their pension goes up.