Is your DC pension scheme resilient for the challenges of 2024? 

2023 was a challenging year for the UK’s defined contribution (DC) pension schemes – and there is little sign of conditions easing during a period of economic, regulatory and geopolitical upheaval.

Given this backdrop and as we look at this year, it’s time to consider the resiliency of your scheme and members to navigate what we expect is on the horizon. We think these are the four core themes for the year ahead:
  • Govern or consolidate

    DC schemes face a continuing deluge of regulations and initiatives that ratchet up the governance load. Delegating some or all of the DC governance responsibilities may be appropriate to consider.
  • Inflation hits home

    Despite its downward trajectory, heightened inflation (as well as increased volatility) affects DC pensions and associated benefits across the board — from members’ financial wellbeing to potential retirement outcomes.
  • Member outcomes

    Helping members understand what their finances are likely to look like in retirement.
  • Sustainability

    Pressure (from a number of sources) to take action on environmental, social and governance issues continues to intensify. Has your scheme determined what’s most appropriate for your membership?

At Mercer, we use data from our own assessments such as DC MOT and RITE (Responsible Investment Total Evaluation) as well as authoritative external sources to generate insights and recommend actions that help you and your members.

We want this to be an easy read so we’ve kept it brief. Please get in touch if you would like to discuss any of our ideas or findings in more detail.

Govern or consolidate — the big question for many

  • 45% of governance committees/trustee boards meet less than every three months.
  • 9% of governance committees/trustee boards meet only once a year and 13% have no governance committee.
  • 27% of employers remain with own trust DC pension schemes while 24% are with a DC master trust.

DC pension schemes face a continuing deluge of regulation and requirements – from climate disclosures to a call for better retirement support and encouragement to invest in illiquids. Some schemes will choose to stick with an own trust model but our data shows that many are not in a position to manage the increasing workload.

To meet these demands, we recommend that governance committees/trustee boards should meet at least every three months. But less than half do so — and many are far short of this guidance. If your scheme is one of the 45% that meet less than every three months, think about why. Have you got the capacity to up your governance game and deal with the mounting workload?

Review your position with your advisor. A consolidation option, such as a DC master trust, may be the right choice for you and your members. However for many schemes, retaining the employer involvement that comes with an own trust, will deliver better member outcomes. For those retaining an own trust they are making moves to consider how they better support their members to, at and through retirement. Options available have developed rapidly and so we recommend that trustees consider this support and whether any element of delegation would reduce the governance burden and improve member outcomes. 

Inflation hits home — and persists

  • UK consumer price inflation (CPI) peaked at 11.1% in October 2022 but the annual rate stayed above 10% until April 2023 — and in October 2023 CPI was 4.6%.
  • Inflation pushed up the cost of a moderate retirement for a couple outside London by 11% to £34,000 in a year, according to the Pensions and Lifetime Savings Association’s (PLSA) Retirement Living Standards.
  • The cost of an equivalent pension for a minimum lifestyle jumped 19% to £19,900.
  • Just 33% of employers have asked their staff in the last three years whether they understand or value their benefits.
  • Only 20% of employers have reviewed their benefits in the last 12 months to ensure they are competitive.

Inflation in the UK is declining but it remains more than double the Bank of England’s target of 2%. The Office for Budget Responsibility predicts that CPI won’t return to target until 2025 and markets expect interest rates to stay higher for longer.

This scenario has implications for employees’ immediate financial wellbeing and their retirement outcomes as members of your DC pension scheme.

Many households have been hard hit by the cost of living crisis after decades of low inflation and interest rates. People are looking to their employers for support, and we are helping many organisations with financial wellbeing programmes. You can also make the most of measures such as salary sacrifice to increase your employees’ take-home pay — and save you money. But your efforts will lack impact unless you engage with your people to find out what they need to help them manage their finances. DC MOT data shows many employers failing to engage with their staff or check that their benefits are good value.

As the data shows, inflation has significantly increased the cost of retirement – and people on lower incomes are hit hardest. The PLSA based its calculations on data from 2022, so we expect inflation to take a further toll on retirement living standards for another year or two.

We have seen little sign of scheme members reducing their contributions because of the cost of living crisis. But we are concerned to hear that members approaching retirement are increasingly cashing in their pension savings, suggesting they are doing so to meet short-term pressures.

Inflation also reduces real investment returns. We calculate that a 25-year-old entering a DC pension scheme today will need an extra 0.5% of investment return every year until retirement to offset high pensioner inflation. This is a significant requirement that is likely to intensify over the next couple of years. Have you got the right balance of risk and return to help your members build a big enough pension pot?

Financial wellbeing is high on the HR agenda and supporting your people doesn’t have to cost a lot. Whatever stage you are at, it’s vital that you engage employees in a two-way conversation to find out what they need. They may want help with problems that your current benefits don’t cover — such as managing debt and day-to-day budgeting. Or they may be unaware of valuable support that you already offer.

Our employee survey and listening programme can help you understand the needs of different groups among your people, show you where to provide help and ensure your employees feel heard. And we urge you to keep talking to your people so that the support you provide stays relevant as conditions change.

You should also remind people about the value of their pension and the importance of having enough saved for retirement. Today’s conditions are an opportunity to get your people more engaged with their pensions. Our Retirement Readiness Index assesses how your pension plan measures up against the PLSA’s standards for different cohorts of employees based on location, age, gender and other factors.

With inflation eating away at potential investment returns for your members, now is the time to review your investment strategy. You may decide you need to change your approach to risk and consider different investment options such as more active management and illiquid assets. These include private debt, private equity and infrastructure. Talk to your advisor about your requirements and the options available.

If you haven’t reviewed how inflation affects these important considerations, now is the time to do so. And even if you have, think about checking again. What seemed appropriate 18 months ago may not be suitable now.

Member outcomes — keep your eyes on the prize

  • 77% of pension scheme savers don’t know how much money they will need in retirement and 51% believe the minimum automatic enrolment rate is enough.
  • 76% of DC schemes don’t model member outcomes to show what kind of retirement they can expect.
  • 54% of employers don’t provide any retirement planning courses for employees.
  • 68% of employers haven’t reviewed their contribution design in the past three years.

DC schemes’ increasing regulation workload absorbs more and more capacity for trustees and company pension managers. Compliance is important but it shouldn’t dominate your agenda.

We believe that one of the most important challenges for DC schemes is to give members to maximise the opportunity to save and invest in order to deliver an adequate and sustainable income in retirement. This is even more important when members are cashing in their pensions to cope with the cost of living and inflation is eroding investment returns and retirement living standards.

Pension scheme members remain worryingly unengaged with their savings and are uninformed about how much money they will need or have in retirement. And many schemes and employers aren’t doing enough to check on members’ likely outcomes, guide their decisions and make sure contributions are effective. This risks the large sums of money you pay into your DC scheme failing to achieve the best outcome for your people.

Now is the time to review your members’ projected retirement outcomes. We recommend that employers should review their contribution design at least every three years. If you are one of the 68% that DC MOT shows haven’t done so, we can help you ensure your contributions are appropriate for members’ outcomes.

Our Retirement Readiness Index produces an objective evaluation of your members’ projected retirement benefits based on the PLSA’s standards.

We can identify members who may be falling short by membership category, location, age or gender. This enables you to make interventions targeted at those groups.

For members of the Mercer DC Master we have introduced Destination Retirement — an automated retirement advice service with web chat and telephone support. Destination Retirement brings advice to DC scheme members for whom this kind of service was out of reach before and is available for arrangements who do not participate in the Mercer Master Trust.

Sustainability — as important as ever

  • 81% of employers have corporate environmental policies yet only 45% of employers believe their DC pension scheme’s investments align with those policies.
  • 30% of pension schemes include sustainable/low carbon assets in their portfolio.
  • 75% of trustee/governance committees don’t fully represent the organisation’s workforce and 31% have given no thought to representation.
  • 36% of schemes have a stewardship policy to challenge managers on voting decisions
  • 58% of trustee/governance committees don’t meet the 40% standard set for representation of women on boards of FTSE 350 companies.

The drive to embrace environmental, social and governance (ESG) values is one of the biggest challenges facing DC schemes. The expectations of government, regulators, campaigners and members are increasing and will continue to do so. As well as seeing the increasing coverage of schemes needing to report on climate related impact (TCFD) the next stage of environmental reporting is nature. The Taskforce for Nature-Related Financial Disclosure aims to replicate the success of TCFD for the natural world.

Scrutiny of pension schemes’ sustainability policies is increasing as campaigners turn their attention to schemes that can, in some instances, dwarf the market value of their parent companies. Yet there is still a worrying mismatch between companies’ environmental policies and the actions of their DC pension schemes.

Mercer’s Responsible Investment Total Evaluation (RITE) survey shows only 30% of pension schemes (DC and defined benefit) have sustainable assets in their portfolios. 58% of DC schemes have an allocation to sustainable assets within their default, a sizeable increase from a few years ago. Consideration of the impact of investing sustainably is becoming a key area for those responsible for designing and implementing investment strategies in schemes. Finally, if your scheme’s investments don’t match your stated ESG goals, you risk reputational damage.

Sustainability isn’t just about climate. To meet emerging regulations and social expectations, organisations are working to improve their policies on diversity, equity and inclusion (DEI). The Pensions Regulator (TPR) has told schemes to make trustee boards more diverse and improve trustees’ understanding of DEI. TPR also wants schemes to make sure the different needs of the UK’s pension savers are understood and met — including appropriate investment options and clear communication.

DC MOT data shows schemes have a lot to do to become more representative. We see forward-thinking DC schemes already making good progress and best practice is developing quickly.

Sustainability poses reputational, HR and long-term investment risks to DC pension schemes. You can’t ignore these pressures.

Many schemes are regularly considering their ESG policies and delivery in this fast-changing market. A good place to start and assess your progress is to undertake a benchmarking exercise to find out how you compare with your peers and best practice.

RITE shows how your scheme scores according to the four stages of our Sustainable Investment Pathway: beliefs, policies, process and portfolio. It will provide:

  • Insight into how well you are currently integrating ESG into your DC scheme
  • Tailored interventions to help you improve
  • The ability to monitor the impact of your actions over time and benchmark your scheme against peers
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