"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."
Falling returns from equity and bond markets could result in significantly lower retirement pots than previously predicted for more than ten million workers paying into defined contribution pensions, according to a new report by interactive investor and LCP.
The report, ‘Is 12% the new 8%?’, examines the impact of lower annual growth forecasts for equity and bond markets on workplace pensions. It concludes that those who planned to save 8% into their pension a decade ago would now need to save 12% to plug the potential gap between expectations.
The report points out that the statutory minimum contribution rate for automatic enrolment pensions – just 8% of a band of ‘qualifying earnings’ – was set in a time when forecasts for growth rates were higher but that things have changed dramatically since then as we move into a ‘lower for longer’ growth world.
The report highlights that many people paying into pensions could be overly optimistic about the rate of growth their retirement pots are likely to benefit from in future. A poll by interactive investor found that one in eight respondents think that equity markets will grow by 10% or more each year for the next 30 years.
Becky O’Connor, head of pensions and savings at interactive investor, 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.
“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.
"But now more of us have defined contribution 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.”
Dan Mikulskis, partner at LCP, added: “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 annum, for stock markets, over the long term, and much less for bonds. But our survey shows that 40% 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.”