A guide to retirement

Over the past decade, the pension saving scene has been dramatically transformed, passing much of the responsibility for building a nest egg on to the individual.

As final salary schemes declined, due to increasing longevity and the costs of sustaining the schemes, more pressure moved to the saver, and with it the burden of making sure one has enough to live on once work ahs stopped.

No more has this come to the fore than with pension freedoms, introduced in 2015. Much has been made of the lack of preparedness of financial institutions, to help people make the right choices with their life savings.

But now there are numerous choices to make, involving many decades of saving, with different approaches to help.

This guide looks at some of the questions this poses, and what solutions the financial services industry offers to clients on their retirement saving journey.

It is worth an indicative two hours' CPD.

Does ‘lifestyling’ clients’ asset allocations work?

Stock market volatility comes and goes, but how it impacts a portfolio can have differing repercussions for those just starting on their retirement planning journey versus those about to embark into their golden years. This is where lifestyling comes in, but does it actually work?

When explaining asset allocation to a client, advisers will often refer to a very rough example of how one's attitude to risk changes as they go through life. 

Typically speaking, a single person in their thirties with no dependents and a long life ahead of them could afford to take on more risk and therefore would be allocated largely to equities.

Conversely, a married couple in their seventies, with estate planning and health concerns to consider, would most likely have a lower allocation to equities.

This is a crude example of lifestyling where the current stage of a person’s life dictates their risk appetite and asset allocation. However, is this approach holding up in testing times?

It is commonplace for advisers to use third parties to forensically gauge their clients’ appetite to risk and then work from there.

A popular provider of this service is Dynamic Planner and its widely-used questionnaires, first developed by Distribution Technology.

Chris Jones, proposition director at Dynamic Planner, says this has been created from extensive work with psychological analysts and academic consultants surveying the entire population.

“The questionnaire enables a user to identify where the client they are talking to would sit on that distribution curve, that is, relative to all the other people in the UK, and thus the risk that they would tolerate,” says Jones. 

“It is then easy to match a client to a suitable investment using the one-10 score. To enable a discussion with the client, we use an example and representative benchmark asset allocation to predict the risk-return trade off in both specific numbers and graphical form.”

Age is just a number 

Lifestyling has attracted its critics from some corners of the advice industry. David Penney, director at Penney, Ruddy & Winter, uses Dynamic Planner to measure clients’ appetite to risk but warns against setting asset allocation purely by age.

“Lifestyling was designed for people in workplace schemes who do not have access to advice,” says Penney. “Typically, a portfolio would move out of equities and into cash and gilts. The idea was that interest rate rises make gilt prices fall and annuity rates rise, whereas interest rate cuts led to gilt price rises and falling annuity rates. The gilts therefore act as a hedge.

Automatically putting all of their pension funds into gilts and cash is no longer a solution
David Penney, Penny, Ruddy & Winter

“This is often not necessary as annuities are no longer the default option and gilts are offering such a low yield by historical standards.”

This speaks to a nuance that Penney argues lifestyling misses, something that bespoke financial advice can help avoid. He adds: “People need to review their investments as they approach retirement, but automatically putting all of their pension funds into gilts and cash is no longer a solution.”

Alan Smith, chief executive at Capital Asset Management, is a fierce critic of the lifestyling approach and insists it underappreciates the threat of inflation.

“Lifestyling is arguably the biggest single destroyer of wealth in retirement,” says Smith, who is concerned about the capital erosion threat it faces retirees with.

“It is a travesty and will lead to real life problems for retirees. It’s built by cookie-cutter investment firms and ticks a few boxes but forgets the underlying problems we are really trying to solve.”

Smith points to a misunderstanding of the concept of risk as a key issue undermining the usefulness of lifestyling.

People often confuse risk with volatility, which can act as a distraction. Here, financial planning is key to helping clients understand what risk is and how it plays a role in their portfolios in retirement.

Navigating the markets

Many independent financial advisers describe themselves as ‘financial coaches’ due to the guidance and education support they offer their clients, who may value this approach more than simple technical issues like tax structuring and investment management.

Amyr Rocha-Lima, partner at Holland Hahn & Wills, says this approach is particularly important when clients become naturally distracted and concerned by headline-grabbing falls in global stock markets.

“I work from a philosophy rather than an outlook, and my overall philosophy of investment advice is goals-focused and planning-driven, as sharply distinguished from an approach that is market-focused and current-events-driven,” says Rocha-Lima. 

“Therefore, the performance of a portfolio relative to a random benchmark is largely irrelevant to someone’s long-term financial success. The only benchmark we should care about is the one that indicates whether the client is on track to accomplish their financial goals and their biggest risk should be measured as the probability that they won't achieve their goals.”

James Wyman, IFA at Lyndhurst Financial Management, explains a lot of his work can involve talking people through the reality of their future lifestyle and how this impacts their asset allocation.

“It’s about showing clients what they need to achieve as a minimum and moving them up the risk scale to achieve their optimum scenario,” says Wyman. “It puts everything into perspective for them, so they understand how risk works and how much of it they need to take.

The only benchmark we should care about is the one that indicates whether the client is on track to accomplish their financial goals
Amyr Rocha-Lima, Holland Hahn & Wills

“I have one client, a former chief executive in the City who had been on a large salary, who assumed he’d need £8,000 of cash a month in retirement. I was able to explain to him that was too much and, given the changes he would make in retirement, he could sustain his lifestyle from £3,500.”

Judging risk

Like many of his peers, Wyman uses Dynamic Planner to guide his asset allocations. Most of his clients sit between risk levels three and seven on the one-10 scale and he does see a change in risk appetite as people move into retirement.

However, he adds this does not mean a wholesale shift into cash and gilts for retirees and explains his company’s centralised retirement proposition is structured to cover both short and long-term capital needs.

“We do slowly de-risk them as they move [into retirement] but it wouldn’t be anything as severe as lifestyling in a general pension fund where it’s more geared towards buying an annuity from retirement,” says Wyman. 

“Our CRP uses a three-pot method. The first pot covers the next 12-24 months of cash; the second pot covers the next two to five years of cash and is with investments in low-risk assets; and the remaining allocation is in assets open to more volatility.

“This means we know we have enough cash that we don’t need to sell anything for the next 12-24 months, and if we do need to sell something we tackle the low-volatility assets first. We make it very clear to the client that we have enough cash on hand for these situations.”

The real risk lies in investing your money in cash, bonds and gilts because of inflation. It is capital erosion in real terms
Alan Smith, Capital Asset Management

A similar approach is adopted by Capital Asset Management’s Smith, with clients retaining the next 12-18 months’ worth of cash for near-term expenses and to keep this capital immune from volatility.

On a broader timescale, he is more willing to open retired clients up to the long-term gains of the stock market.

“I would make a strong case that allocating a significant amount of your capital in retirement to the great companies in the world, spread across thousands of equities, is low risk,” said Smith. “It will be underpinned by a sensible cash management strategy to protect the money you need to spend over the next 12-18 months for bills and expenses.

“[Equity markets] might have occasional volatility, but the risk is low. The real risk lies in investing your money in cash, bonds and gilts because of inflation. It is capital erosion in real terms.”

Long-term planning

But what about the approach taken by large, national advice companies? Rick Eling, investment director of Quilter Financial Planning, explains that the fundamentals in the organisation are the same – volatility comes and goes, and therefore should not influence long-term decisions – but is more cautious about equity investment in retirement.

When asked about how a retirement portfolio asset allocation would differ now to 2000, Eling says the fundamentals have not changed and that more risk equals greater equities.

“If anything has changed in the way portfolios are constructed over those two decades it would be a greater focus on what we now recognise as true multi-asset investing,” he explains. 

“In 2000 there were fewer ready-made and professionally managed portfolios available than today, and many of those took a simple equity/bond/property approach. Modern multi-asset portfolios include wider asset spreads.”

Changes in life expectancy and working patterns are also forcing traditional lifestyling concepts to be evaluated. Rocha-Lima of Holland Hahn & Wills acknowledges the idea of derisking a portfolio at retirement sounds good in theory, but points out this does not match the reality of his client bank.

“Given the stark reality that life expectancy continues to rise, a client in their sixties continues to be a long-term investor,” says Rocha-Lima

“Therefore, they would typically continue to own the same equity-to-bond ratio throughout their financial life, as the requirement for this asset allocation would have been determined when building their financial plan.

“So volatile markets don’t dictate changes to my clients’ investment portfolios. If the client’s financial plan hasn’t changed, then I don’t change their portfolio, because we are continuously acting on their plan rather than reacting to the market.”

Lifestyling has its place, but this is not based on one distinguishing feature – age, attitude to risk and the economic backdrop all have a significant role to play when deciding on the make-up of a client’s retirement portfolio.

Jon Yarker is a freelance journalist

Can multi-asset deliver the best outcomes for clients’ pension needs?

Your clients’ pension pots typically need to be invested in a way that shields them somewhat from the vagaries of the stock market but that leave them with enough exposure to assets that are going to accumulate some capital over time.

Simply being invested in either equities or bonds is not going to be suitable for many clients’ pensions.

“In general, with interest rates at record lows and the enormous stimulus provided by central banks and government spending, returns from equities and bonds have become increasingly correlated,” explains Jamie Smith, financial adviser at Foster Denovo. “Looking forward, they are potentially more sensitive to interest rate rises and future bouts of inflation.”

For many advisers and their clients, the solution lies in multi-asset funds or strategies, given their remit to invest across a range of asset classes. This ensures that pension savings are not left over-exposed to one asset class or region, helping to deliver uncorrelated returns and, ultimately, smoothing out the journey for the end investor.

Ben Kumar, senior investment strategist at Seven Investment Management, says that a well-run range of multi-asset solutions gives advisers the ability to meet most clients’ needs.

It is a simple way of getting exposure to different asset classes from professional managers, often at a relatively low cost
Ben Yearsley, Fairview Investing

While Krupesh Kotecha, financial planner at Balance Wealth Planning, attests that a multi-asset approach to investing works very well for the “vast majority” of his clients.

For Smith, a “true” multi-asset investment strategy seeks to diversify widely within mainstream asset classes, as well as provide exposure to alternatives.

“This is key to potentially reducing volatility, especially the downturns experienced, thus giving the best chance of maintaining the longevity of a portfolio, particularly when decumulating in an environment when either interest rates or inflation are rising,” he adds.

All about outcomes

These types of products are not going to shoot the lights out, and neither should they leave investors with huge losses when they retire. What a multi-asset strategy can do though, is meet client outcomes.

Or as Ben Yearsley, co-founder of Fairview Investing, puts it, multi-asset might not deliver the best outcomes, “but at the same time it also doesn’t deliver the worst outcome”.

“It is a simple way of getting exposure to different asset classes from professional managers, often at a relatively low cost,” he adds.

“My feeling is there probably needs to be at least three asset classes to be multi-asset. With a manager moving asset allocation around in response to different market conditions, you are smoothing the outcome for clients, which is a good outcome in my view – missing the troughs as well as the peaks.”

The popularity of multi-asset solutions is borne out in sales of multi-asset funds, with mixed assets the second best-selling asset class in December 2020, attracting £1.8bn of inflows, according to figures from the Investment Association.

Morningstar’s 2020 fund flows review reported that mixed assets attracted a net £4.7bn in the year, all going to active strategies. The fourth quarter was the asset class’s strongest, clocking up £6.8bn of assets.

Many clients have their pension invested in one fund in a multi-asset range, meaning advisers have helped their clients find the one that best suits their stage of life, such as being close to their retirement date.

The different risk profiles can cater for savers with different time horizons, according to Kumar.

“On top of that, if a client’s aims or risk profile changes, then a multi-asset range offers the possibility of adjusting appropriately, without abandoning the overall investment approach and strategy,” he adds.

He uses 7IM’s own range as an example, which includes the 7IM Moderately Adventurous fund, run by the same team and with the same overall portfolio views as the 7IM Moderately Cautious fund – the former just has a higher weighting towards the riskier asset classes than the latter.

Shock absorber

Multi-asset investing is really intended to weather shocks, such as the one in early 2020 as the Covid-19 pandemic became more widespread. 

Globally stock markets tumbled as much as 40 per cent when countries went into the first of a series of lockdowns, effectively shutting down entire economies.

Then, central banks intervened with plenty of stimulus, sending stocks soaring again and maintaining the rally through most of the year.

So, how would a multi-asset fund have navigated this turmoil for its investors?

"A multi-asset portfolio should contain a mixture of investments, which don’t all pull in the same direction. When the equity portion is falling, there should be diversifiers that mitigate the shock," says Kumar.

“Multi-asset investing is about achieving long-term growth through investing in risky assets such as equities, but then moderating some of the equity volatility through diversifying elements.”

Fairview Investing’s Yearsley says: “If you took a simple equity/government bonds/gold mix and looked at 2020, gold and gilts performed well during the rout in the first quarter when equities were plummeting. What you don’t want, though, is a static asset allocation.”

He explains that once the initial shock had subsided, clients would have wanted their equity exposure to increase in order to take advantage of lower valuations.

In other words, it is not simply about clients being invested in equal parts bonds, property and equities – asset allocation matters if their pension savings are to be protected against market shocks.

One concern is a false sense of diversification when using several multi-asset funds
Scott Gallacher, Rowley Turton

Balance Wealth Planning’s Kotecha reveals just how much of an impact asset allocation has on returns and a portfolio’s ability to recover from a loss.

He says that if an investor was 100 per cent invested in equities, they would have seen a far more significant drop in value at the lowest point of the crash last year compared to a portfolio balanced between equities, bonds and cash.

“An investor that invested just before the crash – on February 4 2020 – would have seen their investment drop by around 32 per cent at the lowest point if they held all of their money in a FTSE 100 index fund versus a 22 per cent drop if they had a global equity index fund,” Kotecha explains.

“Worse still, the investor in the FTSE 100 fund would still be sitting on a -10 per cent loss on February 5 2021 versus the global equity fund that would have reached positive territory by mid-August last year and be up around 14 per cent now.”

He warns that a pensioner drawing income out of the FTSE 100 fund would end up much worse off due to the impact of this prolonged poor sequence of returns.

“Now compare this with the 60 per cent equity/40 per cent bond global index portfolio and this would have seen a drop of around -14 per cent at the same point, would have reached positive territory sooner by early June, and be up at around 10 per cent today,” he adds.

Too simple or too complex?

This is not to say that the multi-asset approach to investing clients’ pensions is without risk. In fact, those performance figures also demonstrate that risk should your clients’ multi-asset strategy not be as diversified as first thought.

“One concern is a false sense of diversification when using several multi-asset funds, where, in fact, they are often highly correlated, despite some managers’ claims,” says Scott Gallacher, chartered financial planner at Rowley Turton.

Foster Denovo’s Smith flags that some funds or solutions are marketed as multi-asset “but still only invest in mainstream equity and bonds with no exposure to alternative asset classes such as property, infrastructure and commodities at all”.

But not all multi-asset funds are so simplistic. Another potential risk is that a multi-asset strategy is invested in highly complex instruments and products that neither advisers nor their clients understand.

Gallacher found during 2020 that the use of structured products in these types of funds can have a “binary stop/go nature and can cause steep and sudden falls in unexpected conditions”, out of line with the perceived risk-approach of the fund.

Yearsley says Ruffer Investment Company’s decision, announced in December 2020, to add a 2.5 per cent allocation to Bitcoin in its portfolio “is an interesting potential inflation hedge”.

However, some of its investors may be surprised to find themselves exposed to the controversial and often highly volatile cryptocurrency.

“But this comes down to knowing your funds properly and what their investment mandate is,” adds Yearsley.

“Troy, for example, on its Trojan fund will only invest in gold, government bonds, and developed market equities – absolutely no risk of investing in things they don’t understand. That isn’t to criticise Ruffer, it’s just as an adviser you need to be aware of the investing parameters of the manager.”

Close scrutiny

Earlier in 2020, asset managers revealed their plans to launch more products in the multi-asset space. Research from asset management consultancy Alpha FMC published in May and reported by FTAdviser found that 53 per cent of asset managers polled said multi-asset funds were in their top three priorities for fund launches in 2020.

With more multi-asset ranges and products available than ever before, advisers will need to closely vet new funds to establish suitability for clients wishing to invest their pensions.

It may sound obvious, but when it comes to choosing the right multi-asset fund for a client’s pension savings, advisers need to look under the bonnet – and not just when the client initially invests, but at regular intervals.

“Some portfolios may not be as diversified as people think and others may be unnecessarily complicated, too costly and detrimental to an investor,” Kotecha says.

“It's important advisers and investors understand what's in the portfolio, the portfolio manager’s approach to multi-asset investing, and just how diversified it is across equities and bonds.”

Ellie Duncan is a freelance journalist

Passive funds in pension planning: the affordable route to long-term success?

Passive investing goes hand-in-hand with pension planning, but sustainability trends are beginning to lay bare the strategy’s limitations.

The role of passive funds in pension portfolio construction has gone beyond simply acting as a safety net for the glossier, actively-managed elements.

Passive funds have been on a tremendous run, so it’s natural to expect growth to plateau at some point
Laith Khalaf, AJ Bell

For many investors and advisers, passive elements have become increasingly integral to the long-term success of pension portfolios, and the properties and characteristics synonymous with passive funds are being capitalised upon.

Yet how much emphasis can be placed on index tracking for long-term pension planning, and what can be learned about the future of passive investing alongside sustainability?

2019 was the year that passive investing truly hit the headlines, as passive equity funds in the US grew to out-value its active counterpart. 2020, too, saw increased growth, but the pandemic-induced economic shock steadied the rise of passive investing, plateauing and slowing the shift as passive-held assets grew marginally to 17.8 per cent from 17.5 per cent.

The suggestion, according to Laith Khalaf, financial analyst at AJ Bell, is that we may be reaching the peak of passives’ climb to prevalence.

“Passive funds have been on a tremendous run, so it’s natural to expect growth to plateau at some point, particularly seeing as the passive price war seems to have abated,” he says.

But while the data would indicate a shift away from passive strategies, for many in the pensions world they still offer tangible benefits that can help deliver successful pensions.

The perks of passive

“Passive funds, by default, are excellent vehicles for pension planning,” says Tania Allerton, head of UK advisory distribution at Vanguard. “Most importantly they tend to be low cost and it’s that low-cost element that is really great for long-term investment horizons.”

Possibly the greatest coinciding factor between pension planning and passive investing is the benefit of a long time frame, coupled with the low costs associated.

One factor driving this is the compulsory automatic enrolment of eligible workers into a pension scheme. Not only is this ensuring that there are more people with an active pension fund, but people are typically opening pensions at a younger age.

This has made passive-orientated pensions more prevalent, according to Nick Porter, chartered financial planner at True Bearing.

“The default investment funds tend to be passively managed. This means that more people will have some experience of passive investments without initially considering the alternatives.”

This can be highly beneficial, especially to younger people with a fledgeling pension, says Porter, as they can begin to capitalise on market exposure without the expenditure associated with a pension.

“During the accumulation phase, where the investor has a long investment time horizon, they would be able to accept the higher volatility expected of passive investments, while benefiting from the typically lower cost.”

Avoiding fees can help in the long-term

“We know through a lot of the studies we do at Vanguard that the impact of costs on an underlying investment can be enormous over time,” explains Allerton.

“Sometimes we are talking very small fractions in terms of the annual management charges, but it’s the impact of those over a significant period of time that really has an impact.”

The average annual management charge paid by investors in the UK is 1.38 per cent a year, and although this may seem like a small figure, the time frame of a pension can cause these fees to greatly detract from the total value.

Over a 30-year period, the effect on a £100,000 pension pot, growing at 6 per cent a year, can total almost £200,000 over the entirety of the term.

“So it is huge. It looks small at the outset but it really compounds. I liken this to compound interest in reverse – it does damage to your savings,” Allerton adds.

Savings in fees are not only applicable for pension holders, but also for pension providers.

Nest is one such example, as Elizabeth Fernando, Nest’s head of long-term investment strategy, explains: “Passive investing plays an important part in our portfolio. We have a tight fee budget to adhere to, as well as wanting to make our portfolio as efficient as possible. That means avoiding high fee costs from traditional active investing, which can place a drag on performance.”

Clients are often less interested in methodology, and far more concerned with results
Paul Cox, Pure Wealth Management

Regulatory changes to fee structure have helped reduce the cost burden of investing, but the true driver of ever-decreasing passive fees is the sheer size of passive-centric asset management companies. By utilising economies of scale, businesses such as Vanguard and Fidelity can afford to continually drop their fees to both attract new clients and incentivise increased flows into their funds.

As such, they can continue to offer returns to investors even when the fund performance is only marginally above the index average.

For Paul Cox, managing director at Pure Wealth Management, the fees payable on an actively managed pension account do not represent good value to his clients.

He says that he finds it “impossible” to present a compelling argument to some clients to pay more than four times the cost for funds that “have performed worse over the long term, the short term, in bull markets and in bear markets”.

Cox argues: “Clients are often less interested in methodology, and far more concerned with results. I feel the evidence is growing to demonstrate that passives do provide not just excellent value, but excellent returns.”

Passive’s persistent performance

The volatility and longevity of the coronavirus pandemic, on paper, did not play into the hands of ardent passive investors. Rather, the opportunities for the nimble, reactionary active investors should have allowed for excess returns alongside protection measures to avoid overexposure to tumbling markets.

Yet data from Morningstar found otherwise. It shows that only about half of active stock funds and one-third of active fixed income funds bested their average passive peer during the first six months of 2020.

“This is really where advice comes to the fore,” says Allerton, who does not necessarily believe that the pandemic has shifted attitudes towards passive investing, but rather has highlighted the value of perspective and advice.

“The adviser is really able to hold their client’s hand during periods of volatility, ensure that they stay invested in something broad and low cost and that’s really shown itself to be the right path yet again through this very difficult period,” she explains.

Can ESG be compatible with passive investing?

But as much of a powerhouse trend passive investing has been, it is increasingly being overshadowed by the monumental swing towards sustainable investing. So much so, that a report by Mercer found that 54 per cent of pension funds recognised climate change risks to their investments – up from 14 per cent the previous year.

Moreover, the overwhelming majority of pension schemes highlighted the awareness of associated risks to broader environmental, social and governance practices.

For Douglas Kearney, investment director at Intelligent Pensions, a passive approach does not align strongly enough with the credentials his clients are increasingly seeking.

“With a passive fund you’re inevitably going to be buying the good, the bad and the ugly – the passive world cannot truly reflect a preference for sustainability,” he says.

Likewise, True Bearing’s Porter says it is a limitation of passive investing that he raises with clients: “If the investor does have any of these preferences they need to understand that they may have exposure to an area of the market that they wouldn’t feel comfortable investing in directly.

“Passive investment would not typically be suitable where the investor has any social, environmental or ethical preferences for their investment.”

But to say that wealth management funds are not tackling the issues surrounding the duality of passive investing and sustainability is not true. Across four of the past five years, net flows into passively managed ESG funds exceeded net flows into actively managed ESG funds, according to data on US funds from Morningstar.

If investors have a strong ESG criterion, then an active play would be more suitable than a passive one
Iain Ramsay, AHR Private Wealth

“There are ways to do passive ESG,” says Vanguard’s Allerton. “But if you look at a broad market index it is fair to say there is everything in there. We use an exclusionary screen that takes out a lot of the things investors would like to avoid.”

Today, there are more than 1,000 ESG indices, and increasing emphasis is likely to be placed on ESG integration within passive investing, be it exclusionary or thematic screening, as more people look to invest and save for their pension sustainably.

Being aware of the exposure a passive pension fund can entail is vital, especially when the individual wants to incorporate elements of sustainability. But Iain Ramsay, chief investment officer at AHR Private Wealth, says that screening has limitations.

“The sophistication of passive investing means that on an exclusionary basis you can remove the sin areas of the economy,” explains Ramsay, but the limitations of a passive approach are laid bare when an investor wants more than an avoidance stance to their sustainably invested pension.

He adds: “If investors have a strong ESG criterion, then an active play would be more suitable than a passive one.”

Only time will tell whether passive can maintain its momentum, but it will certainly be buoyed up by its ardent supporters.

The application of passive investing within a pension portfolio can certainly be fruitful, especially for those with time on their side, but those with fervent sustainability ideals on their mind may need to look for something more specialised or actively managed.

Tom Higgins is a freelance journalist

Pension charge changes are just the start

Better public awareness of workplace pensions, greater competition between providers and increased regulation of the market has seen the cost of saving for retirement fall in recent years.

For workplace pensions, the UK government introduced a cap on the maximum charge that people could be forced to pay back in 2015.

It meant that the maximum amount a saver could be charged for a default fund in their workplace defined contribution arrangement was 0.75 per cent.

The charge cap only applied to workplace arrangements eligible for automatic enrolment, but since it was introduced, charges for non-qualifying schemes have also fallen.

In the updated government’s pension charges survey, released in January 2021, researchers found that charges for non-qualifying schemes fell by 20 basis points between 2016 and 2020, with the average non-qualifying scheme charge now 0.53 per cent.

In addition, all members in the qualifying schemes covered by this research are now below the cap, and the average charge of 0.48 per cent across all members is significantly below the cap. 

“There is little doubt that pensions became very unsexy over a 20 to 30-year period, with downgraded returns and reduced pension incomes,” explains Simon Lister, managing director at ML Financial Associates.

“Legislation has been instrumental in trying to achieve greater transparency over the past 30 to 40 years and help people get more from their pensions by making sure significant costs do not erode the value of them.”

He adds, however, that while charges are very important, cheaper pensions do not mean that they are suddenly attractive.

“With 10 per cent more people holding an active pension now, it does appear to be working – though this is still only 53 per cent of the population,” Lister says.

Increasing engagement

Providers, too, have become more engaged with making their pension products more flexible and accessible as a result of new pension freedoms, the introduction of auto-enrolment and the normalisation of money purchase (or defined contribution) pension schemes.

Simon Goldthorpe, joint executive chairman at the Beaufort Group, explains that this has led to investment houses increasingly linking their investment solutions directly to pension products, “providing clients with a more cost-effective and efficient way to select an investment strategy”.

He adds, however, that this has created a disparity between the newer and older products that are available.

“Newer products typically offer broader investment opportunities, greater flexibility of access options and competitive pricing, those who remain in older arrangements may find their product expensive, inflexible and lacking in choice,” Goldthorpe says.

“We shouldn’t expect to see a drastic change in adviser charges any time soon, especially in relation to more complex pension matters, which take more time and expertise to deal with.

“But with the introduction of auto-enrolment, more and more employers are taking on those costs on behalf of their employees; and with the government now reviewing the pension advice allowance, we may see more advice firms moving to a low cost pension advice offering in the future.”

Behind the charges

Of course, workplace pensions are just one retirement savings market. To gauge whether pensions costs have come down across the industry, it is necessary to look at a broader set of definitions. For private pension arrangements, costs tend to come from three main sources.

Firstly, there are the investment charges levied by the asset manager. 

Then, there are the charges from the pension provider. Finally, those asking a financial adviser to guide them through this marketplace will also likely have to pay for the cost of this advice.

John Simmonds, principal at CEM Benchmarking, claims that in the defined benefit world, the most important change that has impacted cost is the shift towards private market investments. 

“Private equity, infrastructure and private credit are new or growing asset classes for many funds, which are attracted by the prospect of higher returns and, for infrastructure, its liability-matching characteristics,” he says. “However, these are high-cost asset classes, much higher cost than traditional public market mandates.”

It is a given that total costs go up as funds invest more in those private assets and Simmonds explains that a fund with a 10 per cent allocation to private markets might find that those assets account for more than 50 per cent of the total cost of running the fund. 

“Any costs saved by negotiating lower fees from managers are more than offset by the impact of the asset allocation juggernaut,” he adds. 

“We are also now starting to hear of DC funds contemplating private market investments. Incorporating private assets into a default option is tough, given the charging cap. 

“In any event, trustees and providers really need to be leveraging scale to implement these strategies efficiently, avoiding unnecessary layers of cost if they are to have any hope of delivering solutions that are viable for the public.”

Flat fee or percentage charge?

Andy Seed, head of DC solutions at Aviva Investors, explains that Competition and Markets Authority reviews into advice, auto-enrolment and, before that, stakeholder pensions, have all had an influence in exerting downward pressure on pricing.  

He adds: “Intermediaries have also played a big part. Ostensibly, employee benefit consultants and corporate IFAs have been able to drive down costs through the procurement advice process and provider selection exercises. 

“For mono-charge providers such as Nest, Now, B&CE/The People’s Pension, this is unlikely to be a material issue as all clients face the same price.

“For large insurers, differentiated institutional pricing happens on a scheme-by-scheme basis, meaning tariffs might vary significantly between the very largest clients and the smallest.”

A recent piece of research carried out by Interactive Investor found that 48 per cent of those with life company pensions have no idea what fees they are paying.

The research detailed that for someone aged 40, being paid an average salary with modest annual income growth of around 1 per cent, investment growth of 2 per cent and making pension contributions of 8 per cent would end up paying £260 each year in charges based on the 0.48 per cent average charge figure the government cited in its review.

“The government review highlights the need for further support for education and understanding around pension charges,” says Becky O’Connor, head of pensions and savings for Interactive Investor.

“As things stand, whether someone is better off paying a flat fee or a percentage fee depends on where they are in their pension journey.”

She emphasises the importance of clients having a good understanding that flat fees tend to work out cheaper for larger pension balances. The higher the balance, the more likely someone is to save with a flat fee pension. 

“With percentage charges, the amount you pay might start off small – appealing to those in the early days of their pension journey – but build over time into substantial sums. For those with very small pots, as highlighted by the government review, flat fees are not suitable.”

Curbing creativity

While there are positives and negatives associated with both models, Seed argues that the downward pressure risks stifling innovation and the creation of new products across the board.

Sue Pemberton, head of employer services at Premier Pensions, agrees: “On the whole, the reduction in scheme charges over the past five to 10 years is good news for outcomes, for example – a charge of 0.5 per cent rather than 0.75 per cent could result in more than 6 per cent increase in pension pot at retirement for an individual that starts saving at 25 and retires at state pension age.

“However, there is a risk that the continual drive down in charges limits the ability of a provider to develop, invest in research development and continually strive to improve its proposition. As an industry, we need to consider other aspects of a scheme in addition to the charges when assessing its value and suitability.”

The price cap has also pushed providers to make their pension products more flexible and accessible with a wider variety of investment options, while investment houses are now directly linking their investment solutions with pension products.

Rico Cachucho, partner at Hoxton Capital Management, warns that schemes like corporate or private DC pension arrangements still have some way to go. 

“There is no doubt that government regulations on workplace pensions will put further pressure on these outside scheme providers to continue to review their overall fees, but also the way in which these fees are imposed,” he says.

“There are still many legacy pension schemes out there, many of these are older schemes, where members of these pension schemes are paying very high fees and still, in some instances, high exit fees.”

While charges are the main point of discussion here, they are not the only thing that has changed over the past five to 10 years.

Technological advancements and access to information via the internet have also seen a huge push, meaning that customers both demand and can get much better access to greater choice, flexibility and transparency, as well as newer pension products.

“A pension is a great solution to save for the future in a highly tax-efficient way. Unfortunately, high pension product fees can significantly erode the long-term value of that pension over time,” Cachucho says.

“Of course, pension providers, investment funds and financial advisers who are all an important link in the pension chain still need to make a profit to remain in business.

“As time goes on, customers will start pushing for greater value for money and transparency from the recommendations they receive and the products they use to fulfil their retirement needs. All involved in the pension chain will need to adapt to this change in customers’ needs if they are going to survive.”

Jenny Turton is a freelance journalist