Even if you currently have no spare cash to invest, it’s very likely that you are still an investor, in the form of your work pension. Most of us file the annual statements unopened, but over the course of a working lifetime this could be costing you dearly.
(Note that this article talks about Defined Contribution pensions. If you're lucky enough to have a Defined Benefit pension, you can't alter its investments.)
The things you need to try to fix, or at least improve, are the fees and the performance.
Pension companies can play upon our apathy and use it as an opportunity to make more profit from us. If they know that most people don’t price-check and cross-shop for cheaper options, they can creep the fees up both in terms of their platform costs and the fees for the mix of funds they put us into.
Almost everyone remains in the default funds, and these are often terrible.
Unlike a SIPP, with a work pension we aren’t yet in full control. Employers have the power here, and it’s tempting for them to go for the cheapest option, but that can mean you having to deal with a pension provider who doesn’t offer a great range of funds and who has high charges that you wouldn’t have chosen.
The good news is that workplace pensions mean some free money for you. If you are in the scheme, you have to put in at least 3% of your gross wages, and your employer has to put in at least 5%. Some employers are generous and will continue to match higher contributions. Whatever else you do, you should max out this matched contribution as your top priority.
If you are able to opt for something called Salary Sacrifice, this will get you even more free money into your pension. This comes out before National Insurance contributions, and as there’s both employer NI and employee NI, doing this will benefit both you and your employer.
Higher rate taxpayers do particularly well from pension contributions and Salary Sacrifice, as it lowers their taxes a lot.
If that quick run through pensions was a bit hurried for you and it’s all a bit of a blur, have a look at my article on the Wonderful World of Pensions for another pass at the subject.
What should you be looking for on your pension statement?
You want to understand both the fees and the investment options.
Fees
The fees take various forms. Annual management fees in the form of a percentage of the investment pot, contribution fees on new money added, advice fees, fund fees, and possibly exit fees.
Fees are a big killer of performance. That list of fees can easily end up taking a third of your returns if you’re not careful. Each one in isolation sounds reasonable enough, with each being fractions of a percent, but added up they can make up a big chunk of the average 6% annual return after inflation.
If you can get your fees under 0.5% in total, you’re doing great. 0.5% to 1% is okay. Higher than that is getting into ripoff territory.
You’ll probably be able to log in online to your pension account, where you can look at the fees and funds, and make changes. If not, you can certainly phone them to adjust things.
Try to minimise fees by opting out of them where you can - for example, advice fees aren’t usually worth it. Unfortunately many of the fees are fixed and could only be reduced by changing provider - more on this later.
Performance
The other part of this is performance, and that comes down to the funds in which you’re invested. You won’t have as wide a choice here as you would in a self-managed pension on a DIY platform, so the goal for you is to find the least worst option.
Most of us are poorly equipped to select stocks, and paying advice fees for someone to do it for us is usually a waste of money. The best option for most of us is to find a low-cost global, passive index tracker fund. This gives us the average performance of the market, at low cost and without having to spend a big chunk of our lives understanding the stock market.
Pension companies seldom put you in global index funds by default. I’m tempted to say “never”. They will instead steer you toward a curated blend of products. If you were cynical you may think that this is over-complicated to preserve the mystique of their trade and to cause you to leave it alone as too confusing, whilst they continue to take their fees.
Such a blend of products is likely to include bonds, or equivalents under other names such as “fixed income”. I don’t think bonds are the right thing for most people to own - they generally perform much more poorly than stocks. They are, however, less volatile than stocks, so the pension industry like them as a product which causes portfolios to be more slow and steady. Customers are less likely to sell up or complain; they’ll often happily stomach a 6% growth rate even though the stock market is having a bumper year and delivering 25% growth.
Bonds are the easy fix for customers who won’t tolerate volatility. But the outcome in the long-term (and remember that pensions are definitely long-term products!) is significantly less wealth for the customer.
Many companies use a blend known as “lifestyling”, which means giving the customer a progressively higher percentage of bonds as they grow older. They’d do this in a bid to avoid sharp drops in your portfolio right before you retire, but the whole industry goes overboard on it, including many of the popular workplace pension companies doing it with people in their twenties. I think this is crazy - it’s too conservative, too early - and a disservice to you. They’d sooner leave you poorer than try to educate you to cope with volatility.
In my opinion, you should try to hold 100% equities in your pension unless you are about to retire.
Once you retire, I think bonds are still not the answer. Your need for a healthy portfolio doesn’t end on the day you retire; you’re going to need that pot to perform well for as long as you live. I’ll write in more detail elsewhere about dealing with Sequence Risk to cope in the early years of retirement. But even if we don’t agree about this approach, I think everyone would agree that if you aren’t about to retire then you should steer clear of bonds.
So swap your funds. Find the closest thing to a global 100% equities fund with low fees. The lowest fees will probably steer you to the right funds as these are the passive ones without active management charges.
I’d try to avoid “home country bias”, ie too much invested in the UK. We’re only about 4% of the global stock market, so there’s no sense in puttng too much emphasis here. Try not to go for the UK-only funds.
Similarly, I’m not a fan of ESG funds. Many of us want to do our bit environmentally, but ownership of the shares doesn’t really influence the companies to behave well - our spending habits do that. So ESG funds are often an excuse for more fees.
Look for the exit
If your platform fees remain stubbornly high, and you have no good funds to choose from, you still have two possible ways out.
1) You could see if you’re allowed to make “partial transfers”. Many pension companies self-interestedly forbid these, but if they’re permitted then you could sweep your money to a different provider or more probably your own SIPP where you can choose low-fee funds.
2) If you have a helpful employer, you could ask them to contribute to your own SIPP instead of the current pension company. This would be ideal, but it happens only rarely.
Failing all of this, you may need to wait until you leave the job, at which point you have the right to transfer the closed workplace pension to another provider, which is probably going to be your own SIPP. Until then, just choose the least worst fund to have your money invested in.
The impact of making these simple changes can't be overstated. Lacklustre pension pots likely to reach under £50k could very reasonably reach over £200k instead, if you're lucky enough to have some good choices available to you.
What do you think? Are you able to improve your workplace pension? Let me know how you’ve got on in the comments.
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