DC pensions: Savers on course to be poorer in retirement, Aon

The Aon UK defined contribution pension tracker fell slightly during the first quarter of 2023, with younger savers the most impacted. This meant a fall in expected future living standards in retirement provided by defined contribution (DC) savings when compared to the previous quarter.

Aon said the overall decrease masked a "more complex picture for the individual sample savers".

The tracker found older savers benefited from higher-than-expected actual returns in early 2023 and were the least impacted by lower expected future returns.

Over the quarter January to March 2023 the tracker fell from 69.7 to 67.9, driven by reductions in future expected returns, meaning the sample savers’ savings were expected to produce a slightly lower income in retirement than at the previous quarter end.

The negative impact of the reduction in expected future returns was partially offset by stronger investment returns during the three months although this had a more pronounced impact on our older savers who have built up larger current DC pots.

The Aon UK DC pension tracker is constructed by projecting the expected retirement income of four sample DC savers (below) to each individual’s state pension age and then comparing these figures to the ‘moderate’ retirement standard suggested by the living standards.

Drop in retirement income more 'muted'

Compared to previous quarters, the results would suggest savers will have a lower standard of living in retirement than was expected at the end of the previous quarter, but Aon said the fall over the first quarter of 2023 was much more muted than the significant shifts it tracked "during a highly volatile 2022".

All the savers used to compile the tracker, except for the oldest member, were further away from a achieving the revised ‘comfortable’ level of retirement living standard than they were at the start of the year.

Aon's pension tracker found the youngest saver experienced the largest fall in expected income of around £1,075 per year, a fall of 3.35 per cent. 

The 40-year-old saver saw a decrease in their expected retirement income of around £600 per year primarily driven by a reduction in expected future returns over the period until their retirement. This was offset slightly by the positive performance of their existing savings over the quarter.

Savers closer to retirement also saw a reduction in the expected future returns over the period until retirement. However, the positive returns on their larger existing fund value meant the 50- year-old saver saw only a marginal fall over the quarter, of around £180 per year, when compared with the start of the quarter.

The oldest saver was the only saver to see an increase, although it was just £25 per year,  as they are the closest to retirement and so are impacted the least by lower future expected returns.

Aon said UK inflation reached the highest level in decades during 2022, and while this has begun to tail off in the first quarter of 2023, inflation is proving to be ‘stickier’ than first expected.  This persistently high inflation poses challenges for DC savers’ investments, particularly for those in the run up to retirement.

Equities versus bonds

The potential of younger members to see their pension investment increase was greater because of the equity weighting of their investment, older members pension pots will see their defensive asset weighting - such as bonds - increase, but returns on these assets which may struggle to match inflation.  

Many members will not have considered how they are invested or may not feel comfortable making their own investment decisions. They will therefore be invested in their scheme’s default strategy, where the trustees are responsible for setting the investment strategy.

Jo Sharples, chief investment officer, DC solutions at Aon in the UK said: “There is a range of different investment strategies in the marketplace at the moment. In our own funds’ default strategy we take an outcomes-centred approach and favour a higher growth allocation heading into retirement. This reflects most members wishing to access their savings flexibly when they retire, and therefore remaining invested for many years. There will therefore be the need to deliver above inflation growth to maintain the purchasing power of investments as members start to withdraw their savings.”

Inflation-proofing a DC pension

Members could ensure their income keeps pace with inflation through the purchase of an inflation-linked annuity. This would guarantee their income increases in line with price inflation each year, although it may come at a significant upfront cost.

Members who take all their benefits at retirement as cash may not only pay a significant tax charge but will also have to consider what they do with this withdrawal. At current inflation levels, leaving it in even the highest returning bank savings account would see the value reduce in real terms each year.

One element of savers’ retirement income which is guaranteed to keep up with inflation is the state pension, said Aon. This increases most years in line with the ‘triple lock’, rising in line with inflation, national average earnings, or 2.5 per cent, whichever is highest. The 10 per cent increase applied in April 2023 is likely to have come as a welcome boost to current pensioners.