Lower your expectations for pension and Isa growth

The industry will no longer be able to give false impressions of what pension and stocks and shares individual savings account (Isa) investors might receive at retirement, following reductions to the pension projection rates. The Financial Services Authority has given companies until 6 April 2014 to implement lower projection rates in their illustrations to pension and Isa customers.

The current rates of 5 per cent (low), 7 per cent (middle) and 9 per cent (high) give false hope to people struggling to plan their retirement. There are growing signs that we are in a low-growth environment and have been for some time, meaning the regulator has taken too long to address the mis-match between forecasts, expectations and reality.

In defence of the regulator, these projections are simply illustrations reflecting the risk appetite that pension and Isa investors tell their financial adviser or provider. However, in practice they are being taken literally by uneducated investors who think their pensions and Isas are definitely going to grow at an average of 7 per cent a year.

But as readers of Investors Chronicle know, investment growth is not a given. So it is pointless letting people hope for high returns that might never materialise.

The new projection rates of 2 per cent (low), 5 per cent (middle) and 8 per cent (high) should offer a more helpful and realistic guide. All investors should start factoring them into calculations straight away - and making up the necessary short fall (some estimates say the new illustrations of what you will receive at retirement will knock as much as 40 per cent off the previous illustration).

Note that in formulating the new illustrations, the regulator hasn't addressed the real risk facing all investors in stocks and shares - as the FSA always warns customers, the value of your investments may go down as well as up. The idea that there are bad-case scenarios for your pension investments is entirely reasonable. However, the 'low risk' alternative is to put our spare money into cash where it won't get the boost from pension tax relief and where its value is likely to be eroded by inflation.

As well as receiving a fair reality of prospects, people must be encouraged to keep checking what they may be on track to receive - reviewing the actual performance of investments on a regular basis - at least a couple of times a year. And you should also check the charges on investments at the same time - in a world where even the regulator admits that ongoing returns will be lower, charges and costs become even more important. A 1.5 per cent charge is too much to take from a 5 per cent return.

In the case of pensions, the use of investment return forecasts is only one part of the picture when predicting the future. Annuity rates have plummeted by more than 30 per cent in just the past couple of years meaning more and more investors are choosing to draw directly from their pension pots, via income drawdown. However, drawdown clients are facing rock-bottom withdrawal rates so it is important that pension investors understand the risks associated with withdrawing income, as well as of investment returns while accumulating capital. If this leads you to prefer Isas to pensions then go with your instincts.

Old versus new projection rates

Source: Financial Services Authority

How projections will affect investors

Here are a couple of examples of the difference the change in projection rates will make, in terms of what an investor will see, before and after the change.

Source: Hargreaves Lansdown

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