Millennial savers’ pension pots are shrinking fast – here’s why
They are supposed to safeguard our financial future, but the aversion to risk of Britain's biggest retirement funds is now costing pension savers tens of thousands of pounds in later life.
Nest, one of Britain’s biggest pension funds, has come under fire for not taking enough risk with its youngest savers’ money.
The £29bn state-backed fund controls the pension savings of more than 12 million workers.
Most pension funds focus on growing their savers’ money during their early years, because they have the most time to recover from any losses.
However, Nest has shied away from taking risk during the most valuable years in a pension saver’s life, with experts warning of “significant costs” later on for today's workers. Instead, a five-year “foundation phase” for those working and saving for retirement for the first time is designed to “minimise impact of investment shocks” and “promote confidence in saving”. A higher risk growth phase does not kick in until scheme members hit their mid-twenties.
Experts said this strategy risked missing out on the most valuable window for returns in a saver’s life, just when more risk is encouraged in order to benefit from potentially greater reward in the long term.
Nest’s chief executive Helen Dean was paid £240,000 in salary and allowances in 2021-22.
The warning comes after Chancellor Jeremy Hunt vowed to overhaul pension investment rules to follow the Australian and Canadian systems, which allow more money to be put into lucrative – but often riskier – assets.
Mr Hunt said last month: “Countries like Australia and Canada have found a way of making sure that they get better returns by consolidating their pension fund industry in a way that makes it easier for them to invest in unlisted and potentially higher growth vehicles and that's the thing I think needs to be worked on.”
The view was echoed this week by Rachel Reeves, the Shadow Chancellor, who told journalists in Washington that Britain’s pension market should be consolidated so it looked more like the Australian or Canadian systems.
All three of Britain’s largest pension funds – the state-backed Nest, the People’s Pension and Now Pensions – underperformed the largest Canadian and Australian schemes in 2022.
A saver with £100,000 would have been more than £26,000 better off if they were invested in the Canada Pension Plan last year, compared with the biggest fund at Now Pensions, according to calculations by the wealth manager Quilter. They would have been £16,000 better off compared with Nest.
Investing more in venture capital and growth equity funds could add as much as 12pc to a 22-year-old’s retirement savings, according to estimates from the consultancy Oliver Wyman. For a 22-year-old starting out on a salary of £35,000 and contributing 8pc into their pension, this could boost their nest egg by almost £68,000 by the time they reach 68.
Nigel Peaple, of the Pensions and Lifetime Savings Association, the pensions trade body, said it was in “intensive discussions” with the Government about ways to improve returns for savers. He said: “There are ways to improve pensions, like investing in infrastructure and utilities.
“We are in intensive discussions with our members, government officials and financial services to figure out what can be done on the regulatory and fiscal side to make sure it works for pension funds, savers and the Government.”
Unlike most British pension funds, where investment managers must consider the risk appetite of each individual saver, Australian and some Canadian pension funds pool workers’ assets together. This scale means that they are able to take greater risk and secure higher returns, through investments in sectors such as infrastructure.
However, these investments often come at a higher cost. The Australian Super charges a flat administration fee of $1 (53p) a week, as well as an asset administration fee of 0.1pc of each saver’s account balance. That is on top of investment fees, which vary between 0.06pc and 0.52pc, transaction costs, and in some cases additional advice fees.
In Britain, Government rules dictate that overall pension charges are capped at 0.75pc. But too narrow a focus on fees could block British savers from compelling investment opportunities, such as infrastructure projects, according to Rebecca O'Connor of PensionBee, a provider.
She said: “A fee of 0.75pc is relatively low – there is only so much that investment managers can do with that."
The Canada Pension Plan had the highest allocation to alternative investments, accounting for around half of all its assets, while the Nest fund had just 16pc of its money in these types of investments. A spokesman for the fund said that it aimed to increase this proportion to 20pc in the next few years.
But even British pension funds’ more traditional investment strategies are in danger of becoming outdated, experts have warned. Mark Powley, of the pension investment advisory firm Isio, said: “Most people save in the pension fund’s default scheme – that means you start investing in growth assets such as stocks, and gradually move into lower risk assets such as bonds and cash as you age.”
This is based on the belief that stocks and bonds share an inverse relationship – when stocks rise, bonds fall and vice versa. Last year, this theory was turned on its head as a series of rate rises by central banks spooked both stock and bond investors alike.
It meant that thousands of older savers whose pensions had been managed in this way suffered huge falls across their portfolios, just years before their retirement and with little time to earn the money back.
Ms O’Connor said that this lifestyling process, applied largely as a one-size-fits-all approach, needed an urgent update.
“The problem is that we do not all suddenly leave work at 65 anymore – many of us will work longer, or part-time. It doesn’t make sense to start winding down your investments at 55, as pension funds will do, when you could be working for several more decades. You are missing so much growth potential,” she said.
But even top-performing funds are not readily available to all savers, as most have little control over where their pension savings are invested. Workers are automatically enrolled into a pension scheme of their employer’s choice, meaning they have no say over which provider they use to save toward retirement.
A small difference between investment returns can have a profound impact on a worker’s retirement savings. A 22-year-old on a starting salary of £24,000 who contributed the minimum amount into a pension that averaged 2pc each year would have a fund worth £162,160 by the time they reached the age of 66, according to estimates from Quilter.
If that pension made 5pc a year instead, their pension would be worth more than £315,000 – a difference of more than £150,000.
Jon Greer, of the firm, said that the pensions system was a “lottery” for savers. “Performance, fees, investments, and risk profile can vary greatly between providers, and this can have a material impact on the amount of money pension savers have when they reach retirement,” he said.
“In Australia their workplace pension system gives savers the freedom to choose their own superannuation fund from a variety of options or requires their new employer to contribute to their existing workplace pension scheme, known as stapling.”
While the ability to pick your own auto-enrolment provider is still a way off, the Government is lining up a move toward a more flexible Australian and Canadian approach, in the shape of “collective defined contribution”, or CDC, schemes. These allow both the employer and employee to contribute to a collective fund which provides an income in retirement – but unlike a defined benefit scheme, the income is not guaranteed.
It means that they can spread longevity and investment risk across all of the people saving into one fund, rather than one worker assuming all the risk themselves.
Last month the pensions regulator authorised Britain’s first CDC scheme at Royal Mail, which pensions minister Laura Trott praised as a “landmark moment”.
She said: “We have seen the positive effect of these schemes in other countries and our plans to extend our CDC framework will enable more pensioner savers to achieve the retirements they want.”
Britain has one of the largest pension markets in the world, worth more than a trillion. It is little wonder then that the Government is keen to unlock this money to pour into its infrastructure projects – especially as net foreign direct investment hit a record low of net negative £233bn in 2021, according to official figures.
The Shadow Chancellor suggested this week that Labour would be prepared to force pension funds to invest in a proposed £50bn “future growth fund” that would back homegrown, British ventures.
Yet the pensions industry’s agenda, and the interests of its savers, do not always align with that of the Government. Nest has refused to back nuclear projects such as Sizewell C, and most pension funds have strict investment mandates that exclude nuclear assets from their portfolios.
And while the Government hovers over defined contribution pensions, Britain’s biggest pool of assets is tied up in old fashioned defined benefit schemes. These promise an income in retirement, regardless of stock and bond market moves. These generous schemes are now largely closed outside of the public sector. They mostly own bonds, with around a quarter of all British gilts held by insurance firms and pension providers.
Sir Steve Webb, a former pensions minister, said that the Government should be focusing on unlocking the value in these much larger “defined benefit” pension schemes. “The Government has been scared by BHS, Philip Green and Carillion – but we now have very risk averse regulation, and these types of pension funds are awash with cash. Not to take investment risk here is a terrible waste of a £1.5 trillion market that is producing terribly low returns," he said.
Mr Peaple added the pensions regulator’s proposals for new funding rules could further limit these older final salary schemes.
Earlier this year, the Universities Superannuation Scheme, one of the few open defined benefit schemes left outside of the civil service, told The Pensions Regulator, the industry watchdog, it had “deep misgivings” around draft proposals that would curb its ability to invest in British infrastructure projects and generate strong returns for its savers.
In a letter to the regulator, the fund wrote: “We firmly believe that pension fund capital can play a critical role in accelerating growth, increasing long-term investment in infrastructure and supporting the transition to net zero.
“A DB funding regime which does not appropriately reflect USS’s open status and long-term horizons…may reduce its ability to support such objectives, place unnecessary demands on our sponsoring employers and be to the detriment of our members.”
“The pensions industry has long celebrated the success of auto-enrolment, which was hailed as a rare political success story when it was introduced a decade ago.
“But with more than 10 million workers now saving into a workplace pension, fund managers, regulators and the Government must be held responsible to ensure this money thrives in the system they have created. While a focus on low costs and safe saving is commendable, it should not come at the expense of decent growth.”
A spokesman for Nest said: “Our youngest savers, because they’ve only just started contributing, typically have small pension pots and so the benefits of compounding are minimal at this early stage of their savings career. It is far more important that they build up trust in pension savings by not exposing them to unnecessarily high volatility.”
A spokesman for Now Pensions said 2022 had been a difficult year for markets and encouraged savers to focus on the long term.
A spokesman for the People’s Pension said: “Last year was a particularly challenging one for investment markets with significant falls in both the global equity and bond markets brought about by the Russian invasion of Ukraine and the ramp up in inflation as a result of supply chain issues. This wider market environment had an impact on all Defined Contribution investors including our funds.
“Pensions are for the long term and those savers who have been invested in our default fund since 2013, will have seen an annualised return of 7.37%.”