The drawbacks of defined contribution pensions

Kathleen Brooks
IT HAS been a rocky couple of years for pension funds. Some high profile defined benefit plans, such as those of BT and British Airways, have suffered badly since the on-set of the financial crisis. But the problems that have hit defined contribution (DC) plans have not made the same waves in the media.

The one-sidedness of the debate is highlighted in a new survey by Mercer, the consultancy, which reveals just how volatile do-it-yourself pension plans can be. The combination of a recovery in the stock market, cheaper annuity rates and expectations of future equity returns mean that the average DC pension plan member could retire seven months earlier at the end of July, compared to May. But the good news ends there. The projected retirement age for DC plan members has fluctuated by 30 months since 2009.

Mercer’s typical DC member is in his 50s, invests 12 per cent of his salary into his pension and is nearly 100 per cent invested in equities.

Steve Charlton, a senior DC consultant at Mercer, says: “Exceptional market conditions such as those experienced in May and June can have an enormous detrimental impact on the pension income of DC members close to retirement. Yet a swing in annuity rates, as observed in July, can have a significant positive effect.”

Critics of the DC pension model say this is further evidence that the pension industry is not doing enough to help individuals cope with these fluctuations. Mercer’s Charlton says that DC is not as easy as it looks: “Members need more help. In a DB plan, investment professionals make asset allocation decisions for their members, in a DC plan the individual makes these decisions themselves.”

The survey shows that education is crucial. From 2012, the government is going to make it harder for people to opt out of a DC pension plan. A larger percentage of the population will need to make decisions on current market conditions, expectations for future performance and annuity rates. As more people switch to DC pensions, members, employers and the pension fund industry need to work together to ensure a smooth retirement income from DC plans.