An automatic sucess

Employees in the US and Australia are continuing to save for retirement despite falling balances but they are sharply questioning fees and charges, according to pension experts invited to speak at recent Friends Provident Global Forum events.

Workers in Australia are seeing their first negative rate of return in nearly 20 years of compulsory retirement saving. The average rate for the last year is now minus 15% according to Senator Nick Sherry, Australian Minister for Superannuation and Corporate Law. Many people are now asking why they should pay anything for negative returns. David John, an influential Washington policy analyst at The Heritage Foundation reports that US workers with 401(k) accounts are finding that they are down by 40% from their peak and this has caused a backlash. Despite this, studies and polls are showing that 95% of workers continue to save.

These experts also agree that compulsion and autoenrolment have increased the importance of default fund design as most members will not make active decisions about investments.

Both countries are well placed to report on what happens when participation rates in defined contribution schemes are maximised. In the States auto-enrolment is said to have produced ‘stunning’ results taking participation from low teen percentages to the high seventies. Surveys have shown that a high percentage of auto-enrolled people stay in the plans and express gratitude to their employer for the chance to save for retirement.

This should be a very welcome message to the UK government which is planning to introduce autoenrolment into personal accounts for almost all workers in 2012. The news from the US is that autoenrolment reaches the people who need to save but who have tended to miss out.

That said there are still some important details of the UK scheme that need reviewing, and getting it right for a 2012 launch is looking optimistic.

Despite concerns from analysts the government seems in denial about the impact of means testing on the integrity of the state-sponsored scheme. If this is not resolved in the interests of ordinary workers who allow themselves to be auto-enrolled then we can expect a significant amount of resentment when they learn that years of sobriety are not rewarded.

We have still to learn too what the Personal Accounts Delivery Authority (PADA) will do with lost or orphaned accounts, a big problem in Australia, and how the default option will be tackled. As the industry knows only too well, trying to motivate employees to take responsibility for their own investment choices is not a great success story.

Those who are auto-enrolled into personal accounts will have already voted with their feet – or their inertia. Instead of pushing investment fund choice up this particular hill we should be standing back and letting the inertia roll scheme members into good default funds. American providers of 401(k) plans are tackling the issue by not trying to turn workers into ‘chief investment officers’; they are looking instead at putting effort into default scheme design and more specifically into target-dated funds.

These allocate investments according to the number of years an employee will have in the workforce before a chosen retirement date. Single target-dated 401(k) plans automatically allocate investments and adjust them according to a ‘glide path’, in some cases, at five year intervals until the day of retirement. The challenge will be to minimise costs for an option which is neither entirely passive nor entirely active but which could improve default fund returns over the long term.