Key points

  • The cost of living for pensioners has risen significantly, which necessitates a much larger pension pot to sustain a moderate living standard.
  • With additional savings being unaffordable for many, a renewed focus on investment strategy can potentially help bridge the gap.
  • Delivering higher returns with acceptable risk requires enhanced diversification pre-retirement and new ways to mitigate sequencing risk in the retirement phase.
  • Equity income and dynamic factor strategies can work as components within DC solutions.

Higher cost of living

While headline UK consumer-price inflation is helpfully lower now than at any time since July 2021,[1] this does not mean that prices have decreased. The cost for pensioners to have a ‘moderate’ retirement living standard has risen by 34% in the last year alone, according to the Pensions and Lifetime Savings Association (PLSA). It calculates that £31,300 per year is now needed for a single retiree outside London versus £20,800 two years ago – a 50.5% uplift. Couples need 40% more than this.[2][3]

Fixing today’s moderate income level for life for a 65-year-old non-smoker would cost approximately £440k as at 16 May 2024, whereas in 2022, for the PLSA moderate income at that time, the cost was about £378k.[4] Therefore, today’s retiree needs a pension pot that is 16% larger to secure a moderate retirement living standard. Clearly, this ignores the important role that the state pension will play for most retirees. In 2022, at £9,339, it contributed almost half of the PLSA moderate income.[5] However, for the 2023-2024 tax year, at £10,600, the state pension is now only just over one third of the moderate income level. The scale of additional assets needed for a comfortable retirement has, therefore, grown much more than 16% during the period.    

Consider also the plight of a retiree in 2022 who at the time could just secure a moderate lifestyle supported by a full state pension. Today, they would have a slightly higher income thanks to state pension increases. However, their income of £22,062 is now 30% behind what is needed to secure a moderate standard of living.

With great foresight, and in an attempt to tackle this inflation risk, they might have purchased an inflation-linked annuity, despite the fact that these are significantly more expensive to secure; the 2022 retiree would have needed to spend 71% more for the same starting level of income.

However, even the purchase of an inflation-linked annuity is not necessarily protective. Such products tend to be linked to official measures of price inflation which do not necessarily translate to the cost of a moderate retirement, given the differing mix of items in the spending basket. For the 2022 retiree with an inflation-linked annuity and state pension, their income today would be uplifted to only around £23,770, a 14.4% rise from the original £20,800 they had in 2022 to secure their moderate lifestyle. This still falls far short of the £31,300 they would currently need for the same standard of retirement, despite spending 71% more on their inflation-linked annuity.

It is no surprise, therefore, that annuitising remains much less popular than drawdown at retirement despite markedly improved annuity rates. According to the Financial Conduct Authority, figures for Q4 2023 show that the number of people selecting annuities is less than one third of the number choosing drawdown to access their pension pot.[6]

Those who remain invested and draw down an income from their portfolio face an array of challenges, however. In our view, to have even a moderate retirement, it is clear retirees today need:

  1. A more substantial asset portfolio thanks to recent inflation – they will need to accumulate significantly more while working.
  2. To continue to invest materially after retirement in assets that link to the real economy in order to have the potential to keep pace with future inflationary trends over a retirement span that could easily last 25 to 30 years.
  3. To avoid the potential ravages of sequencing risk in their retirement portfolio which can cause permanent impairment to their financial security.

The cost-of-living squeeze on workers means that making substantial additional pension savings is a luxury few can afford. The pensions and investment industry must innovate to deliver new solutions if savers and retired investors are to retain confidence in their future.

How is the pensions industry responding?

There has been a lot of interest recently in facilitating access to private equity for DC savers to unlock additional return potential. The rationale for this is that, despite the unappealing illiquidity and opacity of these assets, there could be additional long-term returns owing to higher growth seen historically in private markets; WTW reported this to be around 5% more per year than returns from listed equities.[7]

However, even assuming this remains the case in the future, a substantial allocation of, say, 10% to private equity would lift overall returns by only 0.5% per year.

Calculations by XPS indicate that those starting on their pension saving journey need to either save an extra 6% to 8% per annum of salary or generate additional investment returns of 2% to 4% per annum over their entire working lifetime in order to deliver an acceptable outcome.[8] 

Given additional savings are unlikely to be forthcoming, investment returns need to do the heavy lifting. Private equity alone looks unlikely to bridge the gap in the return potential needed. How else could investment returns for DC investors be enhanced?

We think two strategies could be critical to help achieve this:

  1. Enhance the diversification of DC investments to support a higher allocation to real assets for longer in both accumulation and drawdown, without materially altering the risk profile
  2. Generate additional returns from existing allocations

How can these goals be delivered?

To enhance diversification, we think schemes could consider the role of dynamic factor strategies as a crossover asset between equities and bonds. These types of strategies can potentially target substantial absolute returns in excess of the expected return of bonds – and some managers can achieve this with little more risk and zero correlation to equities; however, a positive return is not guaranteed and capital losses may occur. Better diversification could improve returns from the lower-risk portion of the DC portfolio. They can also offer daily pricing, access and liquidity in a UCITS wrapper, which is a convenient alternative, useful while schemes wait for suitable private-market offerings to emerge.  

With greater diversification, the portfolio allocation to equity assets can be both increased and re-activated.

Currently, most DC default investment strategies are run to a minimum-cost model. Plan sponsors have been driven to compete on lowering costs to members as these are easy to compare. The result is that most equity assets are held passively in index allocations. This has arguably served DC savers well over the period following the global financial crisis as quantitative easing flooded markets with cheap money, lifting all asset prices and therefore indexes with them.

Why is a different approach needed?

Since the pandemic, inflation has accelerated and so too have interest rates. The era of cheap money has now ended, removing a key tailwind for indices. Equity-index performance has recently been driven by a narrow group of global leaders that now dominate the technology sector, thanks largely to optimism around artificial intelligence. While this may have somewhat further to run, such narrow market leadership could be risky for index investors like DC default strategies. Without the tailwind of cheap money, index performance is expected to be much more uncertain in years to come. A new strategy is therefore needed for DC default investment in equities.

We believe that active management is critical to deal with narrow market leadership, the end of free money and a range of other factors that make the outlook for indices in the coming decade look unappealing. We think that thematically underpinned fundamental research will be key to selecting future winners that will benefit from potential tailwinds, such as reshoring and the energy transition.

What difference might this make?

The value added by active management is never certain so care and due diligence will be needed in selection and oversight. To the extent that a selected manager’s targets are delivered in practice could, however, make a material difference to long-term returns. In addition, with dynamic factor strategies offering the potential for a more diverse portfolio, it may be possible to increase the allocation to real assets such as equities. This could deliver an additional boost to both long-term returns and mitigation of future inflation risks. However, a positive return is never guaranteed and capital losses may occur.

These steps could potentially go a long way to bridging the gap between affordable savings and comfortable retirement, and ought to be an appealing competitive advantage for plan sponsors tired of the race to the bottom on fees.

What about after retirement?

The other factor that can make a big difference to the affordability of a comfortable retirement will be improving the investment strategy following retirement. The current consensus is focused on low-volatility investments in an attempt to avoid sequencing risk. The result is post-retirement portfolios dominated by fixed-income securities. These not only have little prospect of keeping pace with future inflation shocks over a 20 to 30-year retirement span, but also support only low long-term withdrawal rates, potentially leaving retirees short of PLSA target income levels.

Our decumulation research shows that there are ways to tackle sequencing risk directly through asset choices that react well in left-tail events.

Lowering portfolio volatility is an indirect and rather inefficient way to mitigate sequencing risk because it generally comes at a significant expense to return potential. Good overall returns are the primary determinant of a durable decumulation portfolio. Therefore, sequencing-risk mitigation actions that also impair returns can be self-defeating. Instead, our decumulation research shows that there are ways to tackle sequencing risk directly through asset choices that react well in left-tail events.

We find that some assets become sought after as periods of market stress unfold. They therefore recover more quickly than others. This kind of behaviour is particularly helpful to exploit when creating portfolios to support durable decumulation in retirement.

For example, value and quality-biased equity income strategies tend to hold stocks that see an earlier recovery in bids during times of market stress. As a result, they tend to suffer less and recover faster during market crashes, leading to lower sequencing-risk exposure if held in a retirement income portfolio. Tail-risk-protection strategies can also be tuned to help portfolios bounce back quickly, and the high-quality diversification and return potential of dynamic factor strategies have an important role to play too.

These strategies can help build decumulation portfolios that could support durable drawdown and, because they can potentially sustain a materially higher allocation to real assets than is commonplace today, are potentially more likely to keep pace with future inflation over the possible 20 to 30-year retirement span.

At Newton, we run equity income and dynamic factor strategies which can work as components within DC solutions. We also offer bespoke investment solutions which encompass flexible asset allocation, sophisticated risk management and a multidimensional research approach. If you are considering the design of a post-retirement default strategy for your plan, talk to our solutions team.

[1] As at 31 April 2024. Source: Consumer price inflation, UK: April 2024, Office for National Statistics, accessed 5 June 2024:



[4] Source: Newton and Sharing Pensions:

[5] Benefit and pension rates 2022 to 2023, GOV.UK:

[6] Retirement income market data 2022/23, Financial Conduct Authority, 16 April 2024:

[7] Why defined contribution pensions should choose private equity as the first step into illiquids, WTW, 12 April 2024:

[8] CPI falls to 2.3% but has it fallen far enough for DC savers to catch up?, XPS Pensions Group, 22 May 2024:


Christopher Nichols

Christopher Nichols

Head of client solutions


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