The Pension Scheme One-Size-Fits All Approach Is Costing You Thousands

The Pension Scheme One-Size-Fits All Approach Is Costing You Thousands

The pension scheme problem is probably the biggest financial issue facing sovereign nations and companies today. According to the World Economic Forum, the world’s biggest economies are sitting on a combined $70 trillion pension ‘Time Bomb’ that could balloon to more than $400 trillion within four decades unless serious action is taken. One solution is to get workers to contribute more to their own workplace pension scheme, thereby reducing the liabilities for nations and companies.

In 2012 the UK government introduced a scheme called the workplace pension, where employees would be automatically enrolled into a pension scheme run by their employer. This is designed as a behavioral ‘nudge’ to encourage greater participation in pensions schemes, like the famous ‘Save More Tomorrow’ scheme used to increase 401(k) savings in the US.

The logic behind the Workplace pension scheme is that once employees are enrolled, they won’t leave due to the admin effort involved. So far, the scheme has been successful with the Office Of National Statistics declaring that total workplace pension enrollment increased from 47% in 2012 to 68% in 2016.

Alongside the addition of minimum contribution rates, the total amount saved by all employees hit £82 billion in 2015, up from £75 billion in 2012. The Department for Work and Pensions estimates that by 2018, around 10 million out of an eligible population of 11 million people will be newly saving or saving more as a result of auto-enrolment.

So the initiative has accomplished all of its goals, right?

From a top-down perspective, it appears it has. However, an article in the 2017 Behavioural Economics Guide argues that while this state-sponsored pension scheme has achieved some of the goals it set out to, there are flaws in the process, and these flaws are not just limited to UK savers.

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Workplace pension scheme

Workplace Pension Scheme - A massive, underfunded failure?

The problem with most company and state level managed pension funds the article argues, that the investment policy of the pension provider does not match that of each contributor. If you are saving for a particular life event, you invest according to your risk tolerance and time horizon, why should it be any different with a pension?

According to the authors of the report, research suggests that 8.5 million of the 11 million people enrolled in the UK workplace pension scheme are not managing their pension, indicating that £43 billion will be invested thoughtlessly in ‘one-size-fits-all’ defaults funds from 2019 onwards. Most wealth managers will agree that no one single fund can meet the needs of 8.5 million people.

Similarly, it’s apparent that the likes of CalPERS $300+ billion fund cannot meet the individual needs of all of its beneficiaries. The authors of the Behavioural Economics article argue that this apathy towards investing and one size fits all approach, could cost savers an estimated £9 billion per year or £700 per employee through contribution misallocation.

A relatively small change in risk can result in a dramatic change in pension returns over the long term. Figures show just how important it is to manage your own pension risk effectively if you want to achieve the best returns and be rewarded with a most comfortable retirement.

By adjusting risk parameters for different brackets of savers, the authors of the article conclude that self-chosen funds can increase expected retirement income by an average of £4,544 in retirement (typical employee is 25 years old, earning £21,000 before tax, with an 8% pension contribution, retiring at 65, and expecting to receive an annuity for 20 years). In the bull scenario, income could be higher by as much as £30,328 per annum with self-chosen funds. Put simply; it pays to devote extra time to managing your pension according to your own risk tolerance.

pension scheme

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