£160bn bonfire of the pensions

WORKERS' personal pension pots have had at least £157 billion wiped off their total value in the last year, a report out today reveals.

Defined contribution schemes – which account for about a fifth of all pensions – have seen their worth plummet over the last 12 months as a result of the credit crunch.

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And the impact will be even worse following last week's massive global market meltdown.

The erosion in value of defined contribution schemes or workplace stakeholder pensions is the equivalent of a 46,417 loss for each of the 3.4 million workers who pay into such schemes, although amounts will vary according to contributions and investments made. The massive damage to pensions is laid bare in the report by Aon Consulting, one of the UK's biggest pension firms.

It delivers a stark warning to those who are about to retire: they may be forced to work longer.

Ministers are already under pressure to change the rules on annuities. Currently, people coming up to retirement are forced to cash in their investments for a regular pension income. With the value of their investments having dropped, this income level is hit.

The assessment by Aon does not take into account last week's sudden nosedive in the value of shares around the world. In London, 48.9 billion was wiped off the value of FTSE 100 company shares on Friday. The index lost 5 per cent last week and is down around 40 per cent on the past year.

In October 2007, the value of defined contribution pension assets stood at just over 552 billion. By October this year, the value had dropped by nearly a third (28 per cent) to roughly 395 billion.

Over the same 12 months, 6.7 billion of contributions was paid into the schemes by both employees and employers. Those contributions were wiped out by the losses in global equities, where most defined contribution schemes are invested.

Helen Dowsey, principal in the benefit solutions division of Aon Consulting, said the impact of a stock market crash will be much worse on future generations as more of them will have their pension savings invested in equities.

More than 80 per cent of the UK's final salary – or defined benefit – schemes are closed to new workers.

Although there are risks to these funds, the money is often held in safer investments as so many of the participants are nearing retirement age and cannot afford the risk that goes with equity investments.

Employees have little choice in company pension plans. However, a defined contribution scheme can be attractive due to the tax breaks on offer and a top-up from employers.

"In 20 or 30 years or even sooner, it could be a much worse picture. There will be a lot more people with significant holdings in equities," Ms Dowsey added.

And she said there may be a self-fulfilling prophecy in that the turmoil in the markets could destroy investor confidence, which would drive share prices – and therefore pension pots – even further down.

She added that younger investors should not panic, but those nearing retirement who did not have more secure investments, such as cash, had to think about working for longer.

Anyone who bailed out of the market now would also be consolidating their losses, she said.

They would be better off keeping equity investments and possibly topping up their contributions to make up for the losses.

"It may appear a double blow to workers that not only are they facing more of a struggle to make ends meet, but the economic turmoil is also seemingly eating into the money they have been putting aside for retirement," she said.

"However, most workers will have the fortune of time on their side as their retirement will be many years away, enough time to weather the current storm."

Those nearing retirement should go for a "lifestyle option" where five years before retirement, their funds are directed to less volatile investments, such as cash.

But to those thinking of moving investments she said: "Many may be tempted to switch their pension assets held in equities at low value and move into cash, but it's not a good time to do this whilst equity markets are falling – it effectively consolidates losses. For some, it may be a question of delaying retirement."

Older workers hoping to downsize their properties will also be in for a shock, with a huge fall in house prices on the cards predicted to last for at least the next 18 months.

Brian Kite, a senior associate at investment consultancy Mercer, agreed with the cautionary advice to younger investors.

He said: "We need to remember that pension funds are invested for the long term and only a small proportion of members will actually need to draw their funds at any one time."

He said that a typical tracker fund – where half the money is invested in UK shares and the other half in foreign shares – will have seen its value double over the five years to December 2007.

This had been followed by a fall of about one-third since the beginning of the year.

He added: "While the total assets in defined contribution schemes have grown significantly, for a lot of members their monthly contributions are still relatively large compared to accumulated funds, so they should benefit from investing useful sums at attractive prices, ready for when markets recover."

But other analysts warned that the worst was yet to come in the stock market.

Nouriel Roubini, a professor of economics at New York University, who is believed to have inspired the bail-out plan for banks enacted by Gordon Brown earlier this month, warned: "We've reached a situation of sheer panic. Yet I fear the worst is ahead of us."

Case Study - 'No-one is focusing on the prudent investor'

THREE years ago Ian Boyd, a father of two from Innerleithen in the Borders, was considering early retirement at 50 after a life working on oil rigs. But instead he decided to keep working – a decision he now regrets.

"Everything was set for me to take up a personal pension at 50 and get an annuity," he said. "I reckoned that should have given me 30,000-40,000 a year to live on."

For most of his career, he put money into pension fund schemes.

But Mr Boyd, a former Merchant Navy officer and pilot who worked on oil rigs in west Africa and Brazil, kept his bundle of investments worth about 500,000 and went back to work.

He took a job as a counter-clerk at the Post Office because he had seen what happened to colleagues who stopped work and started drinking.

"I decided to stay in work and keep the investments growing," he said.

About 150,000 of the total was in relatively safe profit-making, non-equity investments, he said. Of the remaining 350,000, he has lost about 150,000 in the past year.

"Everyone is focusing on helping people who have been borrowing to the hilt and not on the prudent investor who put something by for retirement. We seem to be ignored," he said. "I've seen this coming for a long time but I thought I would cash in gradually over the next five years, and had started to do so. But it came a lot quicker than I expected.

"There's a mass of us who have put money into Peps and Isas and nothing seems to be said about that. The pension funds seem to have lost about 25 per cent."

He has now joined the Post Office pension scheme, the future of which is still being settled after its final-salary scheme was withdrawn.

He does not expect the financial situation to turn around any time soon, adding: "The difference this time is I really think it is a global situation."

Employees hardest-hit by the slump in the value of their pension pot would be those who are close to retirement and have not moved their funds from equities towards something more secure, including cash or bonds.

An employee who by October 2007 had amassed a 300,000 pension fund in equities could have seen its value drop by about a third to 200,000.

The size of the pot on the day of retirement, plus interest rates, determine the size of the pension.

How to shore up your retirement nest egg

THESE latest figures clearly demonstrate the battering that pension funds have taken in recent months and will undoubtedly come as a huge shock to those investors already nervous about their prospects of funding for a decent retirement.

Although most funds will have seen values fall, it is important to remember that the extent of the damage suffered will largely depend on where your pension is invested.

Our own research has shown that those in more risky sectors – such as global emerging markets, commodities and UK smaller companies – will have fared particularly badly, with losses of more than 40 per cent.

However, those in some fixed-interest and defensively managed funds will have escaped the worst.

It is crucial that policyholders review their pension holdings and consider whether their fund choice still matches their risk profile.

Those approaching retirement will need to consider if they are prepared to accept any further falls in the value of their plan or whether they should switch out of equities into safer assets such as cash.

The alternative is to stay put and wait for the markets to recover. While younger investors still have plenty of time on their side, those who are closer to retirement may ultimately have to consider either delaying their retirement or simply lower their retirement income expectations.

For those with larger pension funds, income draw-down may be an option, whereby you can take 25 per cent of your pension pot as a tax-free lump sum and keep the remainder invested in the stock market.

However, this is not for the faint-hearted and there are no guarantees the value of your fund will recover.

Given the current market turmoil and the unfamiliar territory in which many pension savers find themselves, it is vital to seek expert financial advice before making a move, rather than taking hasty action you may later regret.

• Richard Eagling is the editor of Investment Life & Pensions for Moneyfacts.

Q&A

What is a defined contribution scheme?

This is when workers pay into a scheme themselves, and their money is often invested in shares, stocks and bonds. Contributions are also often paid into the fund by the employer. The total is invested into an individual pension pot and the proceeds are often used to buy an annuity on retirement.

What are the risks?

The amount received on retirement will depend on the returns on investment. The value of this can go up or down. Changing companies often means having to grapple with new pension schemes too, with hefty transfer fees often wiping out any benefits in switching pension providers. On retirement, the member's account is used to provide retirement benefits, often through the purchase of an annuity which provides a regular income. If, however, the investment looks poor at the time it is due to be drawn down, a worker may want to defer retirement until it is in a healthier shape.

What are the advantages of a defined contribution scheme?

These are a tax efficient way to save for retirement for both employers and employees. Participants usually have a say in how much they choose to save although often there is a minimum amount that is required. Savers can usually also say what sort of investments they want.

What are defined benefit pensions?

These are also known as final salary schemes. The size of the pension depends on the final salary of the employee and the number of years that contributions have been made. Savings are held in trust and are pooled to provide an investment fund, which is then deployed to achieve additional growth in value.

Should I bail out of my pension scheme?

If you are a young worker, you have time on your side and the share market is known historically to outperform other sorts of investments over the medium to long term. If you have not actively chosen the sorts of funds you want to invest in, these are diverted to the default fund, which is usually heavily invested in equities. You may want to take advice and divert future savings into other sorts of funds, to balance the risk more widely. However, not saving for retirement is no longer an option, with an ageing population putting ever bigger strains on public sector finances.

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