How pension funds can set you up for retirement

A pension fund is a collective investment designed for people saving for retirement. It includes a range of assets to build your pension pot and set you up for retirement. There are two main approaches to pension funds: the default pension fund approach and the self-select pension fund approach.

Ruth Jackson-Kirby Last updated on 24 April 2021.
How pension funds can set you up for retirement

Pensions can seem like complicated beasts thanks to all the technical language associated with them. But take a little time to understand the lingo and you’ll quickly find that your retirement savings become a lot simpler. Here we look at what a pension fund is.

What is a pension fund?

A pension fund is an investment vehicle you can hold within your pension scheme. Pension funds are collective investments that buy a range of assets with your pension contributions and those of others in order to provide growth and, ultimately, a pot of money that you can use to draw an income from in retirement.

The choice of funds you have will depend on your individual pension scheme. Some will offer you access to a huge universe of funds, while others will have a more limited selection.

Workplace and personal pensions may also offer so-called default or lifestyle funds. These start moving your money into lower-risk investments as your retirement approaches.

» COMPARE: Personal pensions

What is a default pension fund approach?

When you start a workplace or personal pension, if you don’t actively decide where to invest your contributions you will usually be automatically invested into the scheme’s default pension fund. This is a fund that has a portfolio of investments that offers growth with minimal risk.

You will be invested into a default fund based on your predicted retirement age. When you are younger the fund will be in its ‘growth stage’ investing in a range of assets for growth. Then as your retirement age approaches the investment portfolio will gradually move into lower risk, lower growth investments to protect your pot from a last-minute stock market dip that could take a serious chunk out of your retirement savings.

The vast majority of people who are auto-enrolled in their workplace pension stick with the default pension fund. According to Nest, the workplace pension provider, 99% of its members are invested in its default pension fund.

However, the problem with default pension funds is they are trying to suit everyone in the pension scheme. This means it may not actually suit your individual needs. You may be comfortable taking more risk for a bigger reward or want to diversify your investments more. Alternatively, you may prefer a cheaper passive fund or pay more for a specific, actively managed fund.

» MORE: The difference between active and passive investing

Also, default funds tend to de-risk their investments as your retirement age approaches on the assumption that you will want to cash in and buy an annuity. If you don’t plan to buy an annuity but go into income drawdown you may not want your growth restricted by a move into lower-risk investments.

A default pension fund is the easiest option but, as with most things, taking the easy route isn’t always the best route for everyone. It is worth learning a bit more about your pension and what it is invested in and deciding if that is what you want.

» MORE: Basic investment strategies

What is a self-select pension fund approach?

If you don’t want to stick with your pension provider’s default pension fund you can opt for a self-select pension fund approach. This means you pick the funds you want your pension contributions to be invested in.

This approach allows you to personalise your pension investments to suit your attitude to risk and retirement goals.

With a self-select approach you can choose how much diversification you want in your portfolio. This could mean spreading your money across a range of assets from shares to bonds to having wider geographic coverage with investments across the globe.

You can also decide how much risk you want to take with a self-select approach. You may choose to invest some of your money into higher-risk assets such as emerging markets or smaller company funds when you are younger in an effort to boost your growth.

With a self-select approach you can also match your pension investments to your ethics. You can choose to avoid investing in arms dealers, fossil fuels or companies that test on animals or go for funds with a focus on reducing climate change. You can’t control where your money is invested if you stick with the default fund.

» MORE: What you need to know about ethical investing

Be sure to check your pension fund charges

Perhaps the most important thing about your pension fund is the charges that come with it. The amount you pay for a pension can vary hugely from as little as 0.1% for a simple tracker fund to between 0.75% and 1.25%, often more, for an actively managed fund.

The fees and charges on your pension fund can have a huge impact on the final value of your pension. Research by Profile Pensions found that £50,000 invested in a pension fund charging 0.4% would gain over £18,000 more in two decades than the same amount invested in a pension fund charging 1.2%.

This means taking a few minutes to check your pension fund charges could have a huge impact on your eventual retirement income.

» MORE: How to plan for retirement

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

Image source: Getty Images

About the author:

Ruth is a freelance journalist with 15 years of experience writing for national newspapers, magazines and websites. Specialising in savings, investments, pensions and property. Read more

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