There has been a growing demand for better retirement income solutions since Freedom and Choice was introduced in 2015, a reform that opened up an array options for members at the point of retirement. However, while defined contribution (DC) members are no longer effectively forced to purchase an annuity, many in the pensions industry and beyond have feared those in drawdown are in danger of running out of money.
‘Urgent’, ‘necessary’, and ‘important’ were just some of the words used in a call-to action for at-retirement solutions, when Retirement Planner’s sister publication Professional Pensions sought to gain an industry perspective on the subject.
In particular, experts said there is a case for default decumulation or guided pathways. However, this will be challenging – increased policy pressure is needed and member engagement must improve.
Former deputy chairman of the Australian Securities and Investments Commission Jeremy Cooper says the UK is lacking a “sense of urgency”. While DC pots are small, these issues seem a long way off. “That’s what we thought [in Australia], but it takes time to make all of the necessary changes,” he adds.
Indeed, the call for action has been reiterated on various occasions this year. For example, the Work and Pensions Committee’s (WPC) report into the freedoms in April called for the government to consider default pathways in decumulation (although the government has since rejected this). The proposal has received immense support from the likes of the Pension Policy Institute and Columbia Threadneedle Investments, as set out in its Future Book.
The Financial Conduct Authority (FCA) called for drawdown investment pathways to boost outcomes in its Retirement Outcomes Review, while the Pensions and Lifetime Savings Association (PLSA) Hitting the Target report set out a blueprint for retirement income targets.
It would make sense to have pathways in the decumulation phase, given that 10 million people are now saving through auto-enrolment (AE) – which owes its success to the way it harnesses inertia as people need to make an active decision to opt out. This is unlike the point of retirement when members have to make active decisions.
So what would a good retirement product look like? PLSA director of policy and research Nigel Peaple says the DC world we are in now is one which combines drawdown and annuity. “The latter is for when a person becomes older to provide for them against longevity risks. This is important because it helps the individual to make sure they don’t overspend or underspend, and it deals with issues around cognitive decline.”
Some providers have been working on innovative products. For example, in October, Smart Pension and Legal and General (L&G) unveiled a prototype demo of their workplace retirement income initiative, which combines drawdown and annuities. The product offers members ‘four pot’ options: active years, later life, rainy day and inheritance.
Smart Pension director of business development Paul Budgen thinks default pathways is the way forward. He says: “We are big fans of empowering people to get a view of their pension pot and to enable them to do things like pay more in.” According to Budgen, this type of innovation gives people reassurance and flexibility, but also security.
“This is because you have oversight of the trustee board, and the purchase of an annuity which, when you talk to members, is what they want.” Indeed, this can be seen from a research study conducted by L&G with 45 non-advised DC members aged 55 to 65 with a pension pot size of £30k to £250k from May to July. It found that attitudes changed when members worked through their sources of income and expected spending patterns in retirement, and then allocated their money into the ‘four pots’.
Cooper, who is now chairman of retirement income at Australian annuity provider Challenger, says the inclusion of an annuity in a combined portfolio delivers “superior outcomes” for members. As well as providing longevity insurance, he says it “enables a higher proportion of remaining assets in the drawdown product to be invested in growth assets (across the life of the product); can generally create better returns than defensive fixed income investments, such as low-risk bond funds.”
But while having a good product is important, a big challenge still remains: engagement. PTL managing director and PLSA chairman Richard Butcher says: “We are still not very good with engagement and we need to get a lot better.
Almost everyone in the industry would like to improve individual saver engagement and understanding so that members can make these complex decisions.” Indeed, the FCA seems to have the right idea. The watchdog believes a more structured set of options would help consumers to engage with the decisions they are making, consider what their retirement objectives are and ultimately end up with a more appropriate investment solution.
But guidance at the point of retirement is also important. Butcher cites the upcoming Single Financial Guidance Body (SFGB) as an example. The service will officially launch in January 2019, bringing together the Money Advice Service, the Pensions Advisory Service and Pension Wise to provide free and impartial help on money matters including pensions.
Butcher adds: “We also see a lot of potential in fintech. The tools are getting very sophisticated now, so we think an individual who is reasonably savvy can use those tools and get a pretty good feel for what their retirement options are.”
But is there a danger in giving members too much choice? Tor Financial Consulting managing director and owner David Harris agrees that guidance is necessary, but also says “overwhelming amounts of choice incur problems”. He adds: “There is no point selling retirement solutions if you don’t know where the members stand on financial wellness. Do not give members advice; give them friendship. Employers and trustees shouldn’t abandon responsibilities in this respect.” But to do this, trustees and employers need to adapt to the evolving DC landscape.
Cooper believes the industry will have to do a lot more than merely provide investment and asset allocation solutions for retirement income. “Those products do not cut the mustard for most retirees because they don’t have the resources to bear the risks of inflation, longevity and market volatility on their own.”
He adds that as DC savings grow, “there will be increased policy pressure for the market to respond to introducing [combined] DC products”. Meanwhile, Butcher says the basic nuts and bolts of the products aren’t going to change very much until the “clever bits we do around the edges which will influence people’s outcomes. That’s what’s going to change. That’s where the innovation is needed”.
Peaple hopes the future will be as the PLSA set out in its Hitting the Target report. “And it’s more likely to be that if there are product principles. But right now there isn’t a lot of evidence of these hybrid products. I know they are technically feasible but they are not the norm. “There’s a bit of a question mark for why that is the case. Is it because people are not demanding them? I’m hoping the hybrid product route is the way we’re going to go, but it’s not clear.” If he was a “gambling man”, he would bet on the industry going halfway there at least. “But to have a nirvana of good value for money, cash, drawdown and annuity, we think that’s going to get there if it’s nudged along by government and regulators.”
‘Flexible’, ‘secure’, ‘superior’. These are the words that industry experts have used to highlight the benefits of at-retirement innovation. Indeed, the UK’s retirement market is evolving and providers are starting to adapt to the growing demand for technology. Although default or guided pathways may not be the perfect solution to overcome retirement income issues, they would be a big step forward. But to make this a reality, the government needs an extra nudge, and industry must continue to innovate to help people reach good retirement outcomes.
What can the UK learn from ‘down under’?
In July 2017, the Australian government extended the tax exemption on earnings in the retirement phase – currently applicable to superannuation pensions – to other retirement products such as deferred lifetime annuities and in-house annuity products that superfunds, or other financial organisations may want to offer.
Deferred lifetime annuities are a form of lifetime annuity where income payments are delayed for a set amount of time – much like the models which are emerging in the UK. However, according to Harris, in Australia these are “becoming the norm”.
He says: “This is critical. I think it will be five to 10 years before the UK catches up.” According to the Australian government’s website, the term ‘innovative retirement income stream’ covers a range of lifetime products that did not meet the annuity and pension standards prior to 2017 tax changes.
The government identifies these key elements which must be met for a retirement product to be considered an innovative income stream: Similar to an ordinary account-based income stream, the fund is not able to start paying benefits until the individual has met a nil-cashing restriction condition of release; once benefit payments start they must be made at least annually and payable for the individual’s remaining lifetime, along with any primary or revisionary beneficiaries; restrictions on the amount that can be commuted to a lump sum or rollover purposes, which apply after the income stream is in the retirement phase. The restrictions are based on a declining capital access schedule.