As professionals working in pensions dealing with multi-million-pound asset pools, we are sometimes blinkered when it comes to making decisions about relatively smaller amounts of money. We also may not recognise the significance of the growth in DC benefits because of our tendency to look at averages. While DC pots may have a low pound value, they may be the largest pot of funds some individuals will ever see. But is the industry doing enough to help DC members get the best out of their DC pots?
Auto Enrolment (AE) came into play over a decade ago and many of the pension pots accrued to date fall into the small pot category. But this reflects more people having DC membership accounts, rather than saving less. At the end of 2020 the average pot was only around £4,000, and for those retiring was £5,300. However, looking at averages can obscure what’s going on at the member level. While average DC pots have shrunk since AE started by about 75% the number of DC memberships has increased by almost 1000% – from around 2.2 million accounts to 22 million accounts. In addition, there are more than 5.6 million active contract-based DC workplace accounts. With so many more people participating in DC pensions, looking at the average is obscuring our view of how DC pots are growing at the member level.
Categorising a pot as “small” doesn’t mean the amounts are not material to the member. During 2020 the average size of trust-based DC pots increased by around 10% at the same time as the number of pots increased by 10%. More people accumulating even more in DC! Over time those pots will continue to grow and potentially grow quickly. AE contributions are now at 8%. An 8% contribution on the full (rather than just AE eligible) salary with returns of 1.5% above salary inflation could see DC pot size grow to around one times that member’s salary in 11 years if they started contributions today. After 20 years it’s closer to twice the member’s salary, and after 40 years it’s over four times their salary. It may not be much when we’re used to dealing with millions of pounds, but that’s a material lump sum for most DC members, even though it may not support a comfortable retirement.
Yet we leave it to the trust-based DC member to deal with two key risks: (i) not converting that pot at retirement into an income for an appropriate length of time and at good value, and (ii) being scammed.
Regulations require that DB members wanting to transfer accrued benefits worth more than £30,000 must seek financial advice to make sure they aren’t giving up valuable rights. Pension fund trustees are also required to look out for these members to make sure they get advice and warn the member if there’s a chance they’re being scammed. There’s no such duty of care when DC members are moving similarly sized DC pots. Scammers don’t care if their target is DB or DC money. As DC pot sizes grow, they will increasingly be targets for those looking to cheat members out of their money.
The requirement to provide default investment pathway options during the decumulation phase only applies to contract-based DC arrangements, where the member has chosen an account offering drawdown facilities without first obtaining financial advice. So around 22 million trust-based DC accounts don’t automatically qualify for this guidance.
DC members can take a pensions-advice allowance of £500 from their own DC pot, up to three times in their lifetime, to use towards financial advice but, with typical advice fees of 2% of the value of the pot, £500 doesn’t cover much advice. It’s also left to the member to decide whether to get advice and from whom.
Guidance issued by the FCA in March 2021 sets out what employers and trustees can and can’t do by way of providing support on financial matters without needing to be FCA regulated. But there’s a fine line being drawn between education and advice. For many lay trustees and employers, making sure they stay on the right side of that fine line may seem too hard. Afterall, most are not in financial services or the education business. And why should they provide support to members if most of their pension pots have accrued from periods of employment with other companies?
DC pots are going to become a major source of wealth for many and much faster than you might imagine. Thinking about this from the DC member’s perspective will be crucial in making sure that pension benefits are protected for all, and not just those lucky enough to have accrued DB benefits in the past.