Lower growth forecasts could wipe a third off DC pension values

Millions of workers could face ‘life-changing’ retirement shortfalls, according to analysis from LCP and Interactive Investor (II), which has suggested that lower growth forecasts are set to wipe a third off pot values.

The joint report, Is 12 per cent the new 8 per cent?, found that falling returns from equity and bond markets could result in “significantly” lower retirement pots than previously thought for more than 10 million workers paying into defined contribution (DC) pensions.

Examining the impact of lower annual growth, the report concluded that those who planned to save 8 per cent into their pension a decade ago would now need to save 12 per cent to plug the potential gap between expectations.

For a simple portfolio comprising 60 per cent equities, 20 per cent corporate bonds and 20 per cent government bonds, the analysis found that the average real rate of return was 2.4 per cent in 2017, down from 4.2 per cent in 2007.

This means that a typical worker on average pay, who puts 8 per cent in their pension from age 22, would receive a pot forecast of £85,000 based on growth assumptions in 2017, whilst a 22-year old who started work ten years earlier in 2007 would have had £46,000 more, receiving a retirement pot forecast of 131,000.

It emphasised that the 8 per cent minimum contribution rate for automatic enrolment pensions was set in a time when forecasts for growth rates were much higher, arguing that things have since changed dramatically amid a shift into a “lower for longer” growth world.

In light of this, it argued that many people paying into their pension could be overly optimistic about the rate of growth their retirement pots will benefit from in future.

Indeed, a poll from II revealed that one in eight investors expect equity markets to grow by 10 per cent or more each year for the next 30 years, which it highlighted as a "cause for concern".

Considering this, the report has outlined a series of recommendations for individual investors, employers and policymakers to “urgently address” the looming shortfall that could occur if the forecast decline in growth rates is proven accurate.

This included recommendations for providers to make a simple projection tool available to clients, to ensure that future returns can be varied in the projection within reasonable bonds, and to be clear about real versus nominal funds.

It also suggested that the government and regulators ensure the projections investors receive are on a consistent basis and do not depend on which regulatory body set the rules, arguing in particular, that projections in the proposed dashboard for different types of pension should be on a consistent basis.

Commenting on the findings, II head of pensions and savings, Becky O’Connor, said: “This report highlights the impact of lower forecast investment growth on pension pots and the profound implications for the generations of workers whose retirement pots are fully exposed to the fortunes of global markets, without many even knowing.

“‘Lower for longer’ investment growth could mean the difference between scraping-by and being comfortable in retirement, but the impact of stock market performance on retirement outcomes may be poorly understood.

“Now we live in a potentially lower growth world, this needs to be reflected by recommendations for higher minimum pension contribution amounts.”

O'Connor clarified that because of the uplift to contributions from tax relief, pensions still make sense over other ways to invest for retirement even in a lower growth world.

“It’s worth bearing in mind, for example, that headline rates on cash savings accounts do not take into account inflation – if they did they would show minus figures now - whereas forecast growth rates for pensions usually do reflect inflation," she added.

“But now more of us have DC pensions and will depend on them, thanks to auto-enrolment, we may need to look to put more into them, if that’s possible.

“We also need to take care when using online tools and looking at statements that the investment growth rate assumption being used is realistic. A wildly out-of-kilter growth rate can drastically affect your forecast pot size and in turn, your plans for later life.”

Adding to this, LCP partner, Dan Mikulskis, commented: “When we look at our investments, we tend to ask how have they performed, but the more important question is often how will they perform.

“Future stock market returns are one of the most debated areas in investing. The truth is no-one knows for sure. Commonly used assumptions right now expect annual returns of around 5-6 per cent per annum, for stock markets, over the long term, and much less for bonds. But our survey shows that 40 per cent of individuals expect more than this.

“We’ve entered an age of responsibility, where more and more people have now become investors, responsible for their own financial security.

"Looking under the hood of investment products and asking questions like: ‘How much of my assets are invested in stock markets? How much in bonds?’ is vital.

“The industry needs to step up and do better to help investors be realistic here, getting past the jargon and sales guff to actually help produce tools that help savers understand how their money may grow, and the impact of things like inflation and fees over the long term.”

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