Default pension funds are designed to fit the average worker auto-enrolled into a work scheme, and the vast majority of savers remain in them until retirement.
Such funds tend to play investments safe because employers don’t want to get blamed for costly mistakes that endanger their staff’s pension savings.
Most are trackers, which passively match the performance of one or a selection of the world’s stock markets and are cheap to own, although some are actively run to a certain extent.
But work pension schemes offer a ‘walled garden’ of other funds, catering to those who want more actively managed, adventurous, niche or ethical investments, or a combination of the above.
Some pension experts recommend sticking with your default fund, especially if you are not knowledgeable about investing, and around 90-95 per cent tend to do so whether it suits them or not.
But others point out that more adventurous funds, particularly those with higher exposure to stock markets, have historically generated much higher returns over the long run.
We look at how to work out if it is worth keeping your retirement savings within the default fund, and what to bear in mind if you want to move your money to hopefully drum up better returns.
Should you stick with a default fund?
Default pension funds are offered by all ‘defined contribution’ work scheme providers and are broadly suitable for most people, says Fidelity International’s head of workplace distribution Dan Smith.
‘It’s worth remembering that default strategies are designed for those who don’t have the time or experience to manage their own pension,’ he says.
What is a defined contribution pension?
Defined contribution pensions take contributions from both employer and employee and invest them to provide a pot of money at retirement.
Unless you work in the public sector, they have now mostly replaced more generous gold-plated defined benefit – or final salary – pensions, which provide a guaranteed income after retirement until you die.
Defined contribution pensions are stingier and savers bear the investment risk, rather than employers.
‘So if this is you, you may want to start by getting to know your default fund before going down the route of self-selecting.’
He adds that they are diversified in terms of assets, and most also include sustainable – or ethical – investments.
Martin Ansell, a pension expert at NFU Mutual, says: ‘Default funds will be suitable for many employees, and it’s important not to make a knee-jerk reaction after one year of poor performance, as pensions are long-term investments.
‘However, there may be occasions when another fund is more appropriate, depending on your individual circumstances.
‘For example, a 48-year-old planning to retire at 50 may need a different mix of bonds and equities to a 48-year-old planning to retire at 65, or a 48-year-old using their pension as a shelter for inheritance tax.’
David Gibb, chartered financial planner at Quilter, says: ‘Being aware of how your workplace pension is invested is very important, but given people are automatically enrolled into workplace pensions, they often find themselves saving into the scheme’s default fund.
‘While this is certainly better than having no savings at all, you are unlikely to achieve the best possible returns on your investment if you take this approach.
‘Performance can vary substantially across different investments. Even a small difference could significantly increase the size of your pension pot in the longer term.’
What to consider when saving outside the default fund
Workers might end up with a better pension at retirement by diversifying investments within the other funds offered in defined contribution work schemes. Here are six questions to ask yourself when deciding whether and how to do this.
1. What other funds are available?
‘Choosing your own investment line-up in your pension involves having a strategy aligned to when you plan to retire,’ says Dan Smith of Fidelity.
‘Your plan will need monitoring and adjusting to keep you on track, so you should set aside time each year to review your investments to make sure they’re meeting your needs.
‘When choosing your own funds, diversification is important, but this is more than just choosing multiple funds. You need to understand which asset classes, countries and companies are in those funds.’
Smith says you should think about whether the underlying investments provide you with the diversification you need, and how they will help you meet your objectives.
You can research funds on your scheme’s website, but you should look outside it too. A good place to start is This is Money’s Fund Centre, but Morningstar and Trustnet also carry a lot of detailed information about funds, who manages them, and how they have performed.
It is also worth taking a look at This is Money’s jargon buster A-Z guide to the often cryptic names given to funds.
2. How much risk do you want to take?
Your risk appetite is an important consideration, and should be based on how soon you think you are going to retire, says Smith.
‘If you are more than 15 years away from retirement, you may be more acclimatised to risk, whereas if you are 10 or five years away you will want a less risky strategy with more access to cash.’
See more below on ‘lifestyling’, which is industry jargon for reducing investment risk before retirement.
3. What are the charges of other funds in your scheme?
The charge cap on a default fund is 0.75 per cent, and the fees on the selection of other funds available may well be higher.
However, they will still generally be cheaper than if you buy the same fund yourself outside a pension, because workplace providers are able to negotiate bulk discounts.
The Government is looking at whether to ease the default fund cap in future to allow investment in high risk, high reward business ventures and green projects, which tend to have higher performance fees attached.
When comparing fund fees, the key figure to check is the ‘ongoing charge’, which is the investing industry’s standard measure of fund running costs. The bigger it is, the costlier the fund is to run.
David Gibb of Quilter says: ‘Default funds have a charge cap, and choosing an alternative may result in a higher fund charge – though this is not necessarily a bad thing if you can achieve better performance.’
4. How much, if at all, do you want to reduce risk before retirement?
When pension freedoms were introduced in 2015, most people started to keep their retirement funds in investment drawdown plans throughout their old age instead of buying an annuity.
If you plan on staying invested, you might want to avoid having your fund gradually derisked, or what is known as ‘lifestyled’, into safer and lower-risk government and corporate bonds and cash in the last 10 years or so before retirement.
That was the norm ahead of using your entire fund to buy an annuity, which provides a a guaranteed income until you die.
But if you anticipate staying invested for the next 30 years, with the aim of achieving decent growth over that time, it is probably better to stick mainly or wholly with stock market investments in the run-up to retirement age.
The recent bond crash, plus volatile stock markets, have unfortunately left a lot of people in default pension funds that were lifestyled sitting on big losses.
We look at how to mitigate losses if you have a big hole in your pension fund here, and if you are still saving in the run-up to retirement whether you should ‘lifestyle’ or derisk your pension here.
Gibb says: ‘Default funds are ‘lifestyled’, which means that the level of risk associated with your investments automatically reduces as you get older.
‘Moving into a non-lifestyle fund means the risk will not reduce and you will therefore be responsible for reviewing the risk level throughout your life, particularly as you get older and near retirement.
‘If you do remain invested in a lifestyle fund, it is important to check whether it is targeting encashment, annuitisation, or drawdown and decide which is right for your circumstances.
‘You should also check what the assumed retirement age is and whether this matches your plans. If not, it is vital that you change it as the risk level may otherwise not be appropriate when you do come to retire.’
5. Do you want to branch out into ethical investing?
‘Sustainability is a hot topic right now and everyone has a view,’ says Dan Smith of Fidelity. ‘If choosing your own investment strategy, you should consider aligning the investments you choose with your own beliefs.
‘Increasingly, there is data available to show investors the impact that funds have on the environment.’
Fidelity Personal Investing has an ESG fund tool called the ‘Sustainable Investment Finder’ which helps investors search for the ones that meet their goals on sustainability, social action, risk and potential return.
Read a This is Money guide on how to invest ethically here.
6. Should you consult a financial adviser?
‘Where possible, you should seek professional financial advice to ensure you are making the best possible decisions for your personal circumstances and retirement plans,’ says Gibb.
‘Financial advisers have access to tools which allow them to provide broader and more in-depth research and comparisons than you could achieve alone.’
He says seeking advice is particularly important if you are new to investing as you may not feel comfortable with market volatility, and may opt for a low-risk fund as a result.
‘This would be the wrong thing to do for long term pensions savings, particularly if you are still a long way from retiring and cannot yet access your pension,’ he notes.
‘In this instance, remaining in a default lifestyle fund would be a better option as they aim to have the right risk level based on your age, which could therefore achieve better performance than if you were to opt for a low-risk option.’
Martin Ansell of NFU Mututal says if you want to explore changing funds, a financial adviser can help examine your reasons, the risks involved, and the potential alternative funds in your scheme that might be suitable.