In yesterday’s blog post I discussed how George Osborne’s freedom and choice has made it more challenging for scheme members to manage their retirement. Now individuals are no longer required to purchase an annuity, it’s up to them to ensure their pension pots last until they die.
Our inability to plan for the long term makes this task more complicated with many sleepwalking into retirement. Few plan for life as a pensioner and most don’t even figure out what basic income they need.
At the moment, the number relying on defined contribution pots is relatively low as the majority retiring today have defined benefit pensions. But as DB pots fade away, it will become increasingly important to ensure members can use their DC posts to provide a good retirement. If this challenge isn’t met, we could face another crisis in occupational pensions.
So what is the solution to the challenges presented by freedom and choice? Should we be doing more to encourage members to take advice? Trying to educate members better? Or offering products which help to solve this issue?
Educate and encourage
Steps have been taken to better inform scheme members about the scale of the retirement challenge. The government Pension Wise service, which offers guidance to those aged 50 and over, is well received by those who use it.
Guidance, however, can’t take into account individual financial circumstances. The pension advice allowance has been created to encourage members to take financial advice. This allows savers to take £500 from their pension for three years to pay for this service.
The Pensions and Lifetime Savings Association has tried to tackle the lack of financial planning by laying out some possible retirement income in this document. By highlighting these scenarios, it’s hoped people will think earlier on about what they require once they become a pensioner.
While all these services and allowances are a step in the direction, too few take them up because individuals are bad at making long-term financial plans. We suffer from ‘present bias’ – we tend to give stronger weight to short-term payoffs.
Retail providers now offer products such as ‘guided drawdown’ which provides scheme members with an investment strategy for their pension pot to generate an income.
While this is a reasonable solution to the retirement conundrum, the New choices, Big decisions: 5 years on report highlights a number of issues.
These products are offered by retail financial providers which tend to have higher costs then a large DC pension provider.
Over time income products are likely to evolve and include a wider universe of investment options as well embedding sustainable investing practices . But individuals have a tendency to ‘set and forget’ and may not be aware of these better iterations.
Unless scheme members are prepared to pay for ongoing financial advice – which many are not – they will have to work through the difficult decisions associated with setting up a drawdown product on their own, despite having no experience of managing investments.
And income drawdown products do not help members to manage longevity risk. If a member decides to take capital out of their pension pot or fails to protect against inflation, they might see their income become inadequate later in life.
Allow master trusts to offer defaults
These issues could be solved by allowing master trusts to offer at-retirement products. As a larger provider, scale could be used to ensure products are fairly priced. A professional team would ensure investment options are upgraded as better opportunities arise.
By automatically opting members into a retirement product, all members would have the certainty of an income without having to do the heavy lifting themselves. Longevity risks are also easy to manage when they are pooled.
Just as with auto-enrolment, members could opt out of this arrangement if they want to seek their own financial advice or preferred an at-retirement product offered by another master trust.