Inertia has proved an incredibly powerful tool in boosting the number of people saving in a pension through automatic enrolment.
On the back of this policy success, Frank Field and his Work and Pensions Committee colleagues want to harness the behavioural economics principles espoused by ‘Nudge’ authors Richard Thaler and Cass Sunstein, among others, to protect savers from sleepwalking into drawdown without considering their investment options first.
Well, at least I think that’s what they want. I’ve read the committee’s recent 24-page report on the pension freedoms from cover to cover and at no point does it define what a ‘default pathway’ – the solution it argues is necessary for drawdown – is.
In fact, the confusion was such that on the day of publication some believed the report was recommending savers should be defaulted into drawdown at a certain age, while others were talking about mandating withdrawal rates.
At the time of writing I’d had no response from the committee to clarify this (hopefully) very basic question.
However, I’m pretty sure the report is backing the same thing the FCA hinted at on page 102 of its interim Retirement Outcomes Review.
If that’s the case, this is not about withdrawals but investments – and namely making sure non-advised savers who rush into drawdown (often just to get their hands on the 25% tax-free lump sum without taking any income) end up with a suitable solution.
Assuming the committee is referring to the same ‘default pathway’ as the FCA Review, this is broadly how their fix could work:
- A non-advised saver approaches their provider and says “I would like to enter drawdown, please” (SIPP investors are unfailingly polite)
- The provider then responds by sending all the usual documentation and benefit forms
- In addition, the provider will consider information about the customer’s age, withdrawal plans and whether they want to spend all their fund or leave some to their loved ones
- Based on this information, the provider tells the saver their money will be put into Investment Fund X – the default – unless they opt-out (this opt-out could also be provided before someone fills out the questionnaire)
The committee reckons providers should have a solution along these lines in place by April 2019.
As is often the case, ideas like this appear simple and logical at first but quickly plunge into hideous complexity once you take a closer look.
Part of the problem here is the committee’s view that drawdown is a product you buy (a view it appears to share with the regulator).
Indeed, in citing the FCA report, the committee says: “Consumers typically accepted a drawdown product from their pension provider without considering other options. Most such people, wrongly, ‘did not consider that they had made a choice about a retirement income product at that stage’.”
It may in fact be the committee and the FCA, not customers, who are wrong.
Some pensions are a complete product – drawdown being simply a feature of that product. Some others accumulate then require a separate contract for decumulation.
This fundamental misunderstanding, that all DC pensions follow the late 20th century insured personal pension model, filters through to the committee’s recommendation which may therefore be flawed.
The committee assumes all savers make a retirement decision at the point they ‘buy’ drawdown – in fact, many self-invested personal pension investors will have retirement, drawdown and the pension freedoms in mind when they started saving, or at the very least years before retirement.
So while entering drawdown is a useful staging post for reviewing provider and investment choices, the reality is that this review can take place at any time, meaning there is no specific reason this, rather than any other point, must lead to any change on either front.
It’s therefore not clear why those that do nothing at this stage should be shoved into a default investment rather than the investment strategy they were already following.
Given some savers would inevitably fail to opt-out by accident, you would end up with cases where an individual who was perfectly happy with their investment choices is shifted into a default fund they don’t want and forced to pay hundreds of pounds to sell their investments for the pleasure.
Even if you could make the opt-out process somewhere near fool-proof, the idea this is a simple change that can be implemented in a 12 month window is fantasy.
Clearly in drawdown you would need multiple defaults to meet the varying needs of different customers – a point the commission didn’t bother addressing.
Presumably providers would be required to have default funds which meet the needs of people who say they are going to withdraw their entire pot at some point in the short to medium term, those who say they want to take a steady stream of income, those who want to take ad-hoc lump sums and those who want to secure a portion of their pot by buying an annuity – and anything in-between.
You would also probably need different asset allocations based on the age of the individual investor (and any other preferences they had stated).
Furthermore, a questionnaire which results in a product recommendation based on the answers provided looks an awful lot like regulated advice to me – something most providers have absolutely no intention of providing.
None of these practical considerations appear to have been even remotely considered by the committee – perhaps because they don’t have to worry about the details around the ideas they propose.
On a more basic level, assuming the inertia that has made auto- enrolment a success story so far must also be harnessed in decumulation seems to me to be based on a depressingly unambitious view of the world.
As minimum contributions rise, pension pots grow and ideas such as the pensions dashboard take hold, savers should become more interested in their retirement pots – and how they should spend them later in life.
Fostering this increased engagement and promoting the value of advice as this happens should be the central focus for policymakers with any interest in boosting financial resilience in the UK.
Tom Selby is senior analyst at AJ Bell