One of the many good things about defined contribution schemes, from the
employer’s standpoint, is that the employer carries zero responsibility for what
happens to the employee’s fund (barring some not entirely unforeseeable twist of
case law). It is an entirely hands-off arrangement in which the employer
unambiguously hands over responsibility and risk to the employee.
At the end of the employee’s working life there may or may not be enough
money in the pot to fund a decent retirement though the smart money says not.
But according to the strict letter of the law at present, that is not the
As for the employees, in addition to taking on responsibility for the risk
that the fund will not accumulate a sufficient retirement pot, they also gain
the ability to act as their own fund manager. They might not know the first
thing about investment strategies, but their DC scheme will likely come with a
portfolio of funds which they can switch their pot in and out of as frequently
as the scheme rules allow.
Making sense of it
A bit of common sense and a few moments studying the behaviour of retail
investors people who think they have the knowledge and confidence to actively
put money into shares, commodities, property and other asset classes should be
enough to show that this formula is ripe terrain for disaster.
Retail investors are notorious for discovering the investment fad of the
moment six months after the George Soroses of this world have got out. They are
notorious for chasing the market up and chasing it down, buying high and selling
low. Indeed, there are few more successful ways for destroying value than this.
All of this should be obvious to employers and this is why, despite the fact
that the law allows them to take a hands-off approach to their DC scheme, they
should not avail themselves of this apparent freedom. There are two reasons for
this: not only do employees clearly need professional help to have a less
penurious retirement, but also, taking a hands-off approach is not without its
We have already hinted that some future twist of case law could end up biting
employers that do nothing to help their employees get proper advice with respect
to the DC scheme.
Advisers are divided on this. Gary Cullen, head of pensions at law firm
Maclay Murray & Spens, argues that the onus for taking financial advice
falls fairly and squarely on the employee and the employer has no
responsibilities in this direction at all. “The employer’s commitment is fully
covered by the amount they choose or contract to pay into the fund. It really is
that simple and we see no legal risk for the employer,” he says.
Adrian Houlihan, flexible benefits manager at independent financial adviser
(IFA) Origen, disagrees. “This goes, ultimately, to governance,” he says. “There
is mileage in showing that you have fulfilled your duty of care with respect to
the scheme. I would not like to be the employer who finds out in 10 or 15 years’
time that the courts take a view that there is indeed a duty of care owed to
employees transferring from final salary schemes to DC schemes,” he says.
A 2007 survey by Origen found that only 20% of companies provided DC scheme
investment advice to staff, usually by contracting with an IFA to hold
investment seminars and briefings for staff once or twice a year. In other
words, only one in five employers seem to care whether their employees sink or
swim, having flung them into the deep end of investing.
Again, this urge on the part of FDs to put a healthy distance between their
company and its ongoing pension arrangements after years of being tormented by
one layer of official meddling after another with the final salary scheme is
entirely understandable. Whether it is sensible or not is an entirely different
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Tom McPhail, head of pensions research for financial service provider
Hargreaves Lansdown, argues that whatever companies try to do, there is no way
of taking market risk away from employees in DC schemes. “As a company, you can
pass market risk on to the employee, which is what a DC scheme does, but you
cannot get rid of it,” he says.
The most common approach, so-called lifestyling switching into less risky
assets as the employee ages usually wastes value rather than protecting
investors, since it cuts them out of bull runs in the equity markets. “You just
cannot have an investment solution in which everyone is a winner,” he concludes.
“That’s life. What are we do to about it? Not get out of bed in the morning? You
have to take responsibility and get on with it.”
plans going to pot