The Unseen Risk in U.K. Retirement Plans

Defined contribution plans in the U.K. may be jeopardizing the financial security of their members by using varying risk assumptions that turn out to be wrong.

Complacent members of such plans are missing out on investment gains because they don’t know how their retirements plans de-risk their portfolios, according to Camradata. The research provider said in a whitepaper Tuesday that some default funds offered by pension schemes begin adjusting investment risk levels 20 years before workers retire, while others wait until three years before they stop working.

DC pension members in the U.K. used to save for a set retirement date, at which time they’d take their pension benefits and buy an annuity — an insurance product providing an income stream for life. But in 2015, the British government changed the country’s pension rules so members could take a tax-free lump sum at the age of 55 or select an arrangement to draw down their nest eggs. Since then, pensions providers have been making their own assumptions about the likely financial behavior of their clients, resulting in varying approaches as to when to reduce risk in their portfolios.

When individuals take cash from their pension pots, they are “left in the position of having to reposition their underlying investments,” Camradata said in the paper. Some may be in default funds that aren’t suitable. 

Fund firms need to do more to ensure scheme members take control of their own assets, as they will incur additional costs and market-timing risks if they reposition from default investments as they retire, according to Alan Emberson, director of Workplace Solutions at Punter Southall Aspire.

“The default is there for a legal purpose,” he said. “But it needs to change. You could be exposing people to a very risky position at a point in time when they should be de-risking.”

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Hymans Robertson similarly warned three weeks ago that some members of DC master trusts had been “lucky” in recent years, because some trusts have been carrying too much risk leading up to retirement. While more education is needed to help members allocate appropriately, critics of default funds should consider that they also serve a great many investors well, says Sean Thompson, managing director of Camradata.

“Some might argue that a default scheme isn’t necessarily the right scheme that people should be investing in,” he said. “Others say that, as long as you look for the right default fund, and it is invested accordingly, and appropriately, by the asset manager, default funds can actually deliver good returns.”