Picking the wrong master trust could cost members £300 a week
We previously wrote about the importance of setting objectives for Defined Contribution (DC) schemes - here we look at the £ amount impact of poor default design.
We previously wrote about the importance of setting objectives for Defined Contribution (DC) schemes - here we look at the £ amount impact of poor default design. The difference between the best and worst-performing Master Trust default could see a difference in a pot size of over £440k (see note 1) for a member at retirement. That’s around £300 a week in someone’s pocket because of the choice of Master Trust (see note 1).
Inadequacy in DC
As the first generation (in the UK) of members wholly reliant on DC pension’s savings approach retirement, adequacy is likely to be an issue, with people in DC schemes expected to have inadequate savings at retirement.
It is expected that UK DC members will not benefit from the generous retirement packages afforded to the DB generation before them. Research from the PLSA showed 51% of savers are unlikely to meet the Pension Commission’s Target Replacement Rate (£19,162 for a median earner in 2017 – see note 2).
March to Master Trusts
Over the last few years, we have seen Master Trusts grow in popularity, with Master Trusts gaining ground over the last five years across FTSE 350 companies (see note 3). With growing pressure from the regulator and COVID related market falls resulting in many companies evaluating their DC vehicle of choice, we may see further marching to Master Trusts.
Disparity in member outcomes
Several key elements form the decision on which Master Trust is the most appropriate, such as engagement tools, administration capability, member flexibility, charges, and investment approach.
We have long argued that fundamental to DC is the investment strategy: a key driver in whether people retire rich or poor. The difference between the best and worst-performing Master Trusts is 5.5% p.a. over 5 years to the year ending 31 March 2020 (see note 1). This is a difference of £235k in pot size at retirement (assuming this gap persisted over a 40 year career – see note 1).
“The difference between the best and worst-performing Master Trust default could see a difference in a pot size of over £440k (see note 1) for a member at retirement. That’s around £300 a week in someone’s pocket because of the choice of Master Trust (see note 1).”
Taking more recent performance into account, the same analysis over five years to 30 June 2020 results in a larger, and more meaningful, difference of around £442k in retirement pot size or £305 per week in pension (see note 1). Whilst these may seem like extreme examples, they are narrower than it has been in recent years. For example, the gap between the best and worst-performing Master Trust over 5 years to the year ended 30 June 2019 was over 9% p.a. (see note 1).
The market shock experienced earlier this year put further into context the risks members may face. For example, for members two years from retirement, the performance fell as far as 12% (see note 4). Whilst markets moved back since there could have been members that looked to take their retirement benefits towards the end of March. The damage to these members pots would have been lost forever, or peoples’ retirement plans might have needed to change.
We believe DC members should not have a wide range of outcomes. Instead, members should get a sufficient level of income that is insulated against market movements. A little more potential upside from markets is great, but the consequence of getting it wrong on the downside can be profound.
Whether single employer trust or master trust, pensions adequacy for DC members saving at retirement continues to be a major issue despite industry developments in recent years. Contributions, retirement age and investment strategy are the three key levers of DC provision. Typically, contributions and when members retire are largely fixed (or difficult to control) which places a greater onus on Trustees to ensure the investment strategy is fit for purpose.
For more about how we can help you create a market leading, member needs driven investment strategy, please contact your usual River and Mercantile contact.
Note 1: Source: Capadata (performance as at 30 June 2019, 31 March 2020 and 30 June 2020), R&M Solutions (calculations as at October 2020). Assumes 25 year old with starting salary £25,000 invested for 40 years with a contribution rate of 8%. Weekly amount based on single life annuity rates as at 15 October 2020 from hl.co.uk Figures are before tax. Past performance is not a guide to future returns.
Note 2: “Hitting the target: A vision for retirement income adequacy”, Pensions and Lifetime Savings Association, July 2018.
Note 3: “FTSE 350 DC Pension Survey 2020”, Willis Towers Watson, June 2020.
Note 4: “DC Default Review: Weathering the Storm” – Isio, March 2020
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