There is little debate about the fact the pension industry needs to rethink its approach to retirement if it is to improve member outcomes.
It is now eight years since pension freedom rules were introduced, but the decumulation landscape has barely changed, meaning the majority of pension savers get little or no support navigating complex decisions around how to turn their accumulated wealth — via pensions, savings and property — into a retirement income.
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At a recent roundtable event hosted by Corporate Adviser, delegates agreed on the scale of the problem, but there was debate about the most effective way to address this issue. At the core of the debate was the question of whether retirees should get advice or could get by and achieve a good outcome through guidance.
Mercer Workplace Savings head of proposition Stephen Coates said it was clear decumulation had not been seen by providers, regulators, or policymakers as a priority to date. He cited the fact that there isn’t even industry-wide data, covering both contract- and trust-based schemes, to show exactly how people are using these pension pots post-retirement.
But he said that the partial data that is available, from the Financial Services Authority, other regulators and the Office of National Statistics, suggests there are a number of issues in how people are using their pensions in retirement, and this is likely to be a growing problem.
Cashing out
“Figures from the FCA show that when people are accessing their retirement savings, 60 per cent of them aren’t buying an income with it. I think that’s a problem and it puzzles me why the industry doesn’t really perceive that to be a problem.”
He went on to say more than half of pensions pots (55 per cent) are cashed in entirely on first access, with a spike of activity at the age of 55, rather than the normal retirement age of 65-plus. Meanwhile, 40 per cent of savers taking income from their pension are doing so at a rate that is not sustainable over the longer term.
Coates suggested these ‘sub-optimal’ outcomes are partly due to the industry’s reliance on ‘guidance’ at retirement, rather than widening access to advice.
“If you look across the workplace pensions industry we’ve got products, which include flexible access drawdown and annuity, and then we combine that with education, projection tools and income drawdown calculators. There are all sorts of gradations and variations of guidance and education and as an industry we delude ourselves into believing that’s enough to help people make good decisions.”
Delegates attending the event agreed that the regulatory distinction between advice and guidance was not helping. Face-to-face regulated advice remains an expensive service only viable for the wealthiest pension savers. This has led to a proliferation of ‘guidance’ options — aimed at the majority of workplace pension savers. But while providers, trustees and schemes might want to help savers — many are all too aware of the dangers of straying into advice.
Envizage co-founder and CEO Vinay Jayaram pointed out that the current taxonomy used by the FCA bears no resemblance to how consumers and pensions savers understand these terms. “It turns out that what most people consider to be advice isn’t what the FCA consider to be advice.”
He said this reflects the industry’s focus on products. “What the FCA considers to be advice is a series of compliance steps that need to be followed before a financial product can be sold to a consumer.” As a result he said the guidance and information that is often available to people at retirement tends to be more narrowly focused on specific pension products, rather than taking a more holistic look at their total wealth and spending needs in retirement. “If we are working off the wrong framework then it is difficult to deliver better outcomes,” he said.
Guiding principle
But consultants attending the debate pointed out that guidance can take a more holistic approach. WTW director of financial planning Helen Perrin said: “A guidance service can look at all assets and give guidance on that basis. It doesn’t have to be focused on just pension savings. You can ask somebody to complete a fact-find about themselves that takes into account all aspects of their financial situation and then offers guidance on their retirement options on this basis.”
However, Perrin pointed out the key difference is that guidance won’t produce a personalised recommendation, telling people exactly which product to buy. This can be a significant barrier when it comes to getting individuals to actually take the steps needed to fulfil the decisions they had come to.
She added: “You would have recourse to the Ombudsman, whether it’s guidance or regulated advice, if you’ve been told something that’s inaccurate or misleading.”
Scottish Widows senior corporate pensions specialist Robert Cochran said many people are reluctant to “press the red button” — despite guidance on what might be a suitable course of action. “They might say I think this is what I need to do, but they are hesitant to make these big decisions without someone to help them do it.”
This can be one of the shortcoming of guidance services. But as he pointed out this can also be a problem with some ‘robo’ advice services — that might give a tailored recommendation, but still rely on the customer to action this themselves.
Those attending the debate agreed that any guidance or advised solution needs to address these psychological barriers, as well as number-crunching the financial details, be it the size of savings pots, expected longevity and projected investment returns to determine what a sustainable income stream might look like.
Behaviour matters
EBC Collective partner Charlie Goodman said: “Rather than worrying about the end income, we need to go further back and make sure we are taking account of people’s mindset, their behaviour and their biases.” Part of the problem is auto-enrolment’s success is largely built on inertia, he said, with people not having to make active decisions about their pension savings. As a result the choices that need to be made around retirement can be “overwhelming”.
“We need to be engaging people at a far earlier stage,” he said. If not, there is the danger that people have already made the decision to take cash from their pension at 55, and education or guidance at this point can be ineffective.
Cochran agreed it is important to understand the psychological factors behind retirees’ decision-making processes — or non-decision-making processes. He pointed out that people now primarily see their pension as a cash pot, rather than a potential income stream. He said this also applies to defined benefit pension pensions as well as DC savings.
People see the cash as something that belongs to them he said, and even a relatively small sum in the bank can make them feel more secure and considerably richer.
They may intend to convert this to an income at some point, he said, but this does not necessarily always happen. Jayaram said not enough research has been done around why so many people choose to cash in their pensions. “My hypothesis is the industry is about income because the industry has the tools and products to deliver an income. People are about cash because they’ve lost trust to a certain extent in the industry and in the politicians.”
Cochran added that another psychological barrier can be people’s reluctance to make a ‘forever’ decision that is not reversible at a later stage. It is for this reason that Cochran said investment pathways, which represent a guidance approach to decumulation, appear to be popular with pension savers, from what he had gleaned from the client calls he had listened in on. People genuinely seem to like them he said.
“It is easier to engage people. If you ask them what they plan to do with their pension over the next five years they can answer that.” Asking them to draw up a plan for the next 20 to 30 years is more daunting, and not surprisingly many simply put off making a decision.
These investment pathways highlight two other problems with the current retirement system. The first is the fact that retirement shouldn’t be a “once and done” issue. All the consultants attending the event highlighted the need for regular financial reviews during retirement, with amendments being made as personal and wider economic circumstances change.
The other issue raised by attendees was the regulatory gap between contract- and trust-based pensions. Only FCA-regulated pension schemes are currently required to offer default investment pathways at retirement, although the majority of master trusts offered by life insurers now have similar pathway options too.
Single-trust concerns
Buck benefits consulting leader Mark Pemberthy agreed there are differences between the two regulatory jurisdictions, particularly when it comes to taking benefits at retirement. This doesn’t just cover default pathways, but the functionality of schemes in terms of flexible drawdown options, as well as the advice, guidance and information available.
“I think it’s important to differentiate between master trusts and single-employer trusts,” he said. “Many larger master trusts are now mirroring the kind of capabilities available within contract-based arrangements. But this is not the case for most single-employer trusts.”
Barnett Waddingham partner Andy Parker agreed this is an issue — and one he would like to see policymakers tackle head on. Trustees of these schemes typically see their remit and responsibility around accumulation, not helping members make the right decisions when it comes to retirement income, which is exacerbating this problem, he said.
“Policymakers and regulators need to just get on with it, and say get your own trust into a master trust or GPP. Don’t give them an option. Don’t do it by stealth. Just get on with it.”
Contending with complexity
Coates said that many of these issues could be addressed by more people getting advice on their retirement options. “It’s not necessarily that advice conceptually is a better concept than the guidance,” he said. “But I think at the moment that’s the best mechanism we have for helping people navigate what is essentially a very complicated decision.”
Guidance has sought to simplify retirement issues, but he does not think this is helping consumers in the long run. “Time and time again you hear people say we need to make it simpler. But the problem is I’m not sure you can make it simpler. It’s a bit like shouting at a brain surgeon saying you’ve got to make the brain simpler. When you are trying to help people make better retirement decisions you need to contend with the complexity.”
Regulated advice, Coates said can deal with these complexities — but the cost of delivering it has been prohibitively expensive for those with more modest savings. Technology has been seen as a key way to reduce the cost of delivering this advice, and it is to this end that Mercer has launched its new Destination Retirement service.
Coates positions this as a “third way” which aims to “democratise the advice process to broaden its reach” by removing much of the upfront cost.
This is a regulated advice service, although users also have a ‘self-service’ guidance option, and options to model income scenarios well ahead of any retirement decisions. Coates said this isn’t just streamlining the advice process by moving the fact-finding process online. “The advice itself is produced algorithmically.”
Coates hopes this new service will address many of the issues raised by consultants during this debate. It is designed to help people meet their spending requirements in retirement — rather than be specifically focused on product recommendations, be it an annuity or drawdown.
“Part of the point of this product is the customer doesn’t need to make any decisions about drawdown or annuities or longevity risk. You have to tell it what you want, in terms of spending, and it calculates the best way of generating this.”
This service will ask about individual’s and their household’s wider wealth, including savings, Isas, bank accounts and pensions, and from next year there are plans to include property wealth.
Stochastic advice
Coates said the algorithm models a sustainable income, and will review this on a regular basis. It will also suggest the most tax-efficient way to sequence these income withdrawals, from Isas, general investment accounts, pensions and cash savings.
“If you have all these types of savings there are 24 different ways you can sequence these products, or 48 for couples who each have these accounts.
“Every time you run the tool it will go through 80 million calculations to come up with the different scenarios with the one at the top being the most tax efficient. The difference that you can pay in tax between the most and least efficient sequencing can be as much as 25 per cent over a lifetime.”
Although, it has only be available for a year Coates said that take-up has been encouraging and significantly more than the number using the telephone-based restricted advice service that was previously offered.
Coates said there are some advantages with a digital service, with some people preferring to disclose financial information to a non-judgemental machine. However some consultants pointed out that there were still limitations with these digital services not least when it comes to engagement.
Parker said: “I am still struggling a bit with the idea that people have to tell it ‘what they want’. I think that this is the heart of the problem: a lot of people really don’t know what they want at all.”
Parker said he would like the starting point to be a default option that tries to improve member outcomes, particularly for those who are least likely to engage with their pensions. An advice programme that bombards them with questions at retirement may not necessarily address this issue he said.
However, Coates said that it is very much about how these questions are framed. “If you ask people what their attitude to risk is, whether they want an annuity, or how much they want to invest for long term care, then you are not going to get very far because most people don’t know the answers to these questions. “But if you ask them what their Netflix bill is, how much they might spend on a car when they retire, or how many holidays they would like to take a year then people can answer these questions. This can be a good starting point to making better decisions around retirement.”
Platform blues
For the past 10 years there has been talk of ‘robo-advisers’ reshaping the financial landscape — but to date few have caught on. Coates said part of the reason was the technical-challenges launching a platform like this.
“If you look at the workplace platforms out there the vast majority just don’t have the APIs and the digital capability to offer an automated programme of this complexity. There are very few people who can build these sophisticated digital products.” He said HUB used the Embark platform to build the ‘Destination Retirement’ product as this was the only platform that was able to handle the digitisation of this product.
But he said he expects others to follow suit, and this platform may have a range of other competitors in future. “I think if we can push the industry to modernise their products, and if this is supported by the right legislation we will be able to build a more flexible architecture that can support more automation. “This has the potential to really transform the advice landscape which in time I would hope will help deliver better