2 October 2012 Last updated at 19:00 ET

Investment choices after pension auto-enrolment

Money Talk by Tom McPhail Hargreaves Lansdown

Tom McPhail says that people should conduct an annual review of their pension provision

Even after workers are automatically enrolled into their employer's workplace pension, they must not assume that their retirement planning is all taken care of.

Millions of employees in the private sector are being enrolled into a workplace pension over the next six years.

Staff, employers and the government will pay into a worker's pension pot. Contributions will be invested and when the employee retires, currently at 55 at the earliest, they will have to buy an annual pension, or annuity, with their accumulated pot.

The default auto-enrolment contribution rate is extremely unlikely to deliver an adequate retirement. The eventual contribution rate of 8% of earnings comes from 4% from the employee, 3% from the employer and 1% from the government in tax relief.

So, there are still a number of issues workers are going to have to think about if they want to make sure they will enjoy a decent retirement income.

How much you should be contributing to your retirement fund is almost certainly the single most important question to consider.

Checking the detail

If you do nothing else then my one piece of advice would be for you to spend five minutes using one of the many free online pension calculators to work out how much you should be saving and when you might be able to afford to retire.

It would also be prudent to review your pension progress on an ongoing basis right through your working life - at least once a year - because circumstances change and it is important to make sure that your pension keeps on course.

Auto-enrolment criteria

• Workers not already in a company pension scheme will be enrolled if they are aged between 22 and the state pension age
• However, these workers must be earning at least £8,105 a year
• The contribution they, and their employers, make will be based on their wage, although the first £5,564 a year they earn will not be taken into account
• Any earnings above £42,475 will also be ignored in the contribution calculation
• So the amount between £5,564 and £42,475 is known as their pensionable pay
• Staff can opt out

• Test your money knowledge
• Q&A: Pension automatic enrolment

Investment choices will matter too. All auto-enrolment schemes are required to have a default fund, so you can join the pension without having to choose where your money is invested.

For most people though, the default fund is unlikely to be the best choice.

For some people it will be too low risk, taking a conservative approach that could reduce returns. For others it might be too speculative, risking investment losses with which they would feel uncomfortable.

Most pension schemes will offer their members the choice to select an alternative fund to the default.

There are two points to bear in mind here. For people in their 20s and 30s, the priority should be to invest boldly, using funds invested predominantly in company shares around the world, including developing economies.

The contrast to this is for investors approaching retirement, who have to make sure their pension fund is invested in the right funds to meet their needs.

Someone planning to buy a lifetime annuity, to secure a guaranteed income in retirement, would probably want their pension fund to be invested in fixed-interest investments - mainly in gilts.

By contrast, someone looking to use a drawdown plan - which allows retirees to take income from their pension fund while the fund remains invested - would want to keep their pension invested largely in company shares right up to and beyond their retirement date.

Choices available

Most schemes will offer a range of fund choices, from cash to funds invested in company shares. The range of choices will vary, with some schemes offering just one fund while others offer dozens, hundreds or even thousands of investments to choose from.

If your employer signs you up to the Nest scheme (the government designed National Employment Savings Trust), then the default fund will be based on when you are expected to retire.

It will invest mainly in government gilts at the outset, moving to company shares in the middle of your life and moving back to a mixture of gilts and cash on the run-in to your expected retirement age.

This is to ensure that pension savers see their pot grow steadily at first as they get used to the idea of having a workplace pension, before bolder investments are made to try to grow the pot, ahead of a cautious approach when approaching retirement.

It makes sense to limit the number of pensions you are saving into as you go through your working life.

Workers change jobs 11 times on average, according to the Department for Work and Pensions (DWP). It is very possible that every time you change jobs you will get a new pension from your new employer.

This can make staying on top of your retirement planning quite a challenge. So wherever possible, try to keep consolidating your pensions into one pot as you go along. This will be particularly helpful in the run-up to retirement when you may need to act quickly if you are trying to secure a particular annuity rate for yourself.

Workers do have the choice to opt out of auto-enrolment. If you do this, you will not have to pay your share of the monthly contributions, however you will also miss out on the employer's contributions.

Given that the combined impact of the employer contributions and the tax relief is to double your money (you pay in 4%, you get 8% of your pensionable earnings put into your pot), you will struggle to match this deal anywhere else.

You can ask your employer to pay the contributions into a pension you have chosen yourself, but it is unlikely that they will comply. If you do opt out of the auto-enrolment scheme, the chances are you will just get nothing because employers are specifically banned from offering their workers any kind of inducement to opt out.

The default option for everyone should be to join their employer's pension and just be grateful for their contributions towards your retirement.

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