Workplace pensions: how NEST will invest your compulsory pension

As NEST, the Government's compulsory pension scheme, gets ready to launch, we look at how your pension will be invested.
If you’ve got a job and you’re not saving for a pension, a big change is about to hit you. The Government’s new auto-enrolment scheme is about to start and that means you may be obliged to save into a pension.
Indeed, some people will be automatically enrolled in a pension scheme as early as this October. If you don’t like the sound of this, you’ll have to make the effort to opt out. If you do nothing, you’ll be saving for a pension whether you like it or not.
It’s up to your employer to decide who will operate your workplace pension scheme, but it’s expected that many employers will go with NEST, a new Government-backed pension provider.
As there’s a good chance you’ll end up with a NEST pension, I thought it would be worth finding out more about how NEST will invest your pension nest egg.
Retirement date funds
Most NEST savers are expected to invest their pensions in retirement date funds – also known as target date funds. These are funds that are managed on the basis that you’re most likely to retire in a particular year.
So if your most likely retirement date is 2025, your pension will be invested in the 2025 retirement date fund. If your most likely retirement date is 2055, you’ll be invested in the 2055 fund.
You can read more about retirement date funds in A better way to build your pension. I’m a big fan of these funds because they mean your pension will be invested in appropriate assets for your age.
So if you’re 35, you can afford to have a fairly risky investment portfolio because you have plenty of time to recover if share prices fall. But if you’re 58, you won’t have that time, so it makes sense to invest in lower risk assets at that point.
Phases
NEST’s retirement date funds will be split into three phases. Let’s look at them in more detail:
1. Foundation phase
If you’re joining NEST in your 20s, your early contributions will mainly be invested in low-risk assets. Only about 30-40% of your cash will be invested in the stock market.
That might surprise you. It surprised me when I first heard it. In fact, I thought this approach was a big mistake. It goes against what I said earlier about investing in higher risk assets when you’re young.
That said, NEST’s chief investment officer, Mark Fawcett, has persuaded me that it’s not such a dumb idea after all.
That’s because NEST has done some extensive research into the attitudes of twentysomethings to investment risk. It turns out that many young people react extremely badly to any sign they might be losing money.
Let’s imagine that NEST invested 90% of all Foundation phase investments into stocks and shares. Let’s then imagine that the stock market had a bad year and fell by a quarter. If that happened, there’s a big danger that young savers would be very upset and opt out from auto-enrolment for many years to come.
But if twentysomethings have a lower risk portfolio, they’re more likely to carry on paying into their pension for the rest of their working lives.
NEST’s research shows that people in their 30s are less scared by one or two bad years. So at that stage, it makes sense to put people’s money into riskier assets.
The most important thing is that twentysomethings start contributing at a young age. If they do that, they’ll have a nice little pot that can be invested in higher risk assets once they reach their late 20s or 30s – the growth phase.
2. Growth phase
This is when greater risks are taken. The greatest risk will probably be taken when you’re in your 40s, and after that there will be a gradual shift to less risky assets.
Although there’s a broad framework for how the risk levels will change, Fawcett does have some room to ‘flex’ his investment decisions if that’s appropriate. In other words, if stocks and shares look cheap, he might invest a bit more than normal in the stock market. And if they look expensive, a bit less than normal.
But whatever the market conditions, Fawcett is determined to consider a broad range of assets including property and corporate bonds. He’ll never invest more than 80% of any fund in the stock market.
3. Consolidation phase
The consolidation phase is for when you’re heading towards retirement – probably for the last ten years that you’re working. Your fund will increasingly be invested in low-risk assets such as gilts.
Other funds
Although it’s expected that most people will go for the appropriate retirement date fund, there are some other options you can choose from. These include a high-risk fund, a Sharia-compliant fund and an ethical fund.
Charges
The other really important investment issue is charges. NEST will charge an annual charge of 0.3% on all your assets plus 1.8% when you first invest the money. So if you invested £1,000 this year, you’d pay a 'contribution charge' of £18, and if your total pot was worth £10,000, you’d pay a £30 annual charge. If you invested a further £1000 next year, you'd be charged a further £18 contribution charge on that fresh investment.
The annual charge is very reasonable but the contribution charge is on the high side at 1.8%. Sadly, NEST has to pay back a loan to the Government, so that’s why it has to charge so much. That contribution charge will probably be cut back at some point, but it’ll be a while.
In spite of that high contribution charge, I think that NEST’s overall investment approach looks sound. If I worked for an employer that offered a NEST pension, I’d be happy to stay enrolled. No opt-out for me.
More from lovemoney.com
Auto enrolment: your salary will fall by £300 per year from October.
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I am now of pensionable age. I am so glad that I never saved a bean towards a pension with a 2nd party. Not one of them turned out to be trustworthy. I trusted to myself only and not others. Providing you are disciplined enough you can put the money aside using it to invest in your own way - the only thing against this is that the M.P's (via HMRC) have a knowledge of what we have in our bank accounts and so have made sure via the banks that now we receive our state pensions etc we get no interest on it. Still it's time to have a spend I think - no point in being the richest person in the cemetary. The Government will tax us on anything they can - the only thing you do without being taxed is be born and be under 18. After that unless you never work at all you will get taxed - perhaps something for the next generation to think about. We were bought up to work hard and save but my experience is that nobody thanks you for it - on the contrary having nothing and living on credit is rewarded - certainly working and saving is not.
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ronat42. I think Alan Thomas made the same point you do, namely that even the most reputable private pension company can go bust when government regulation is not fit for purpose. Why therefore trust a government sponsored scheme? Poohbah also correctly observes that in the future members of HMG will be unable to resist the temptation to change the rules when they see billions just sitting there tempting them, just like Gordon Brown's raids on 'excess profits'. We need sensible rules, engraved in tablets of stone, along with sensible money that is not being depreciated every year by deliberate money printing. MK22 observes correctly that flying pigs trailing a banner of truth are more likely. I'm with Joe Easdale. Think localism and DIY, or prepare to be disappointed. Nest will be similar to NI, just another form of PAYE.
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AlanThomas makes a point of comparison with Equitable Life. I think he has missed the point somewhat as that organisation failed because of the the same problems which caused the demise of most of our major companies. I.E the actions of over ambitious and forward thinking new age executives which had little to do with the factors he mentioned. These causes were allowed and wrongly dealt with by the incompetence of those bodies who were charged with the task of looking after our interests and their total failure to control them and making appalling decisions in a failed attempt to deal with the result. Unfortunately, that record does not encourage confidence in the Nest scheme.
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11 August 2013