Based on ONS and NHS data, there’s an 85 per cent chance that people in the UK between the ages of 55 and 75 experience a fundamental reshaping of their income needs during retirement due to unforeseen life events (health, care, divorce or death). Irreversible decisions during this period create a risk of feeling ‘financially trapped’ when change comes along.
We need to foster confidence for members by making decisions more incremental and based in familiar terms like income and expense, rather than a larger one-off decision which increases the risk of regret. That’s the only way to meet this era of unpredictability and highly personal objectives, while planning for greater life expectancy, which brings with it increased inflation risk and adequacy concerns.
Designing for uncertainty and learning from behaviours in more mature DC markets will lead to better outcomes than funnelling retirees toward one-way doors that leave people exposed to unpredictable life events. Annuities and R-CDCs offer value for some, but we should be very clear: they hardcode rigidity into a life stage defined by unpredictability, and may prevent households from adapting to changing circumstances or passing on wealth for the next generation.
There is undoubtedly a behavioural bias toward a ‘guaranteed income’ as none of us have a clue how long we’re going to live. Elimination of risk always comes with a price tag, but for far too long we have accepted not knowing the true cost of an annuity.
The reality for someone aged 65 is that the cost is, on average, between 25% and 40% of lost lifetime income through adviser charges, lost investment returns and loss of bequest.
The lack of transparency or awareness that individuals have when purchasing annuities should fill us with dread at a time when the industry is very clearly looking to maximise value for members.
Scaled retirement defaults are coming via the Pension Schemes Act to help us improve value, but the proliferation of new ‘flex and fix’ annuity structures could potentially increase those costs in an already opaque structure due to lower competition.
Risk sharing is compelling in theory, but the practice is another matter entirely. R-CDCs promise smoother income, cohort efficiency, and pooled longevity risk. But it’s naïve to stop the analysis there as the real test of any CDC system is fairness to ensure wider suitability.
How do you reconcile longevity differences between affluent and deprived regions, or avoid lower-paid or disabled workers underwriting the CEO’s longer lifespan?
Examining R-CDC in detail creates a domino effect of complexity. Scale thresholds and advisory costs rise, necessitating it being a default benefit solution. But as a default, it must be transferable so members aren’t locked into a structure they never chose. But if it’s transferable, this comes at significant cost (up to 30%) and you have lost the pooled investment benefits when compared with the accumulation default’s retirement portfolio that already offers scale and value.
For some members, RCDC may work beautifully. But for the majority, it risks feeling unfamiliar, opaque, inflexible and not offering income certainty to support planning – another oneway door dressed as modernisation.
The scale and maturity of the US market offers huge insight into our future and access to innovative solutions that offer greater flexibility.
Larger pension pots increase both decision anxiety and the importance of bequest planning. So as UK DC matures, this will become increasingly important and raises concerns for the future of annuities and R-CDC.
People want income, not irreversible decisions that come with a product sale. Delivering automated and regular retirement income from drawdown spreads the decision making, reducing the risk of getting it wrong, while offering flexibility to personalise objectives.
The US have also developed an innovative way of regularly valuing an annuity, enabling people to have guaranteed income for life with the flexibility to transition between pot and income at all times.
The message is powerful; you don’t have to sacrifice flexibility for peace of mind.
Retirement is an era defined by its unpredictability, and a one-off decision at 65 could easily be regretted at 75. Breaking it down into a sequence of smaller decisions with continuous education and support helps members navigate subsequent life events with confidence and secure their essential expenses on an ongoing basis.
By designing for uncertainty rather than pretending it doesn’t exist, we can help members make a lifetime of smart choices without trapping them behind one-way doors.
