Nobel prize winning economist William Sharpe famously called decumulation the “nastiest, hardest problem in finance”; the UK government believes it may have found a solution through guided retirement legislation.
Current arrangements in defined contribution workplace pension schemes place enormous onus on savers at the point of retirement with little support, pushing them towards large cash withdrawals or an annuity scheme that may not be right for them in the long term.
If someone remains invested in drawdown, it can lead to significant financial decisions being made in one’s 80s or even 90s. As former pensions minister Steve Webb points out, the spectre of “cognitive decline” is an important aspect to remember in this issue.
As part of the Pension Schemes Act, which became law in April of this year, was the concept of guided retirement.
Namely, the trustees or managers of a relevant scheme must design and offer to members a retirement solution that meets their needs and offers a suitable pathway throughout the drawdown or annuity phase, all while avoiding complex decumulation decisions in later life.
“Guided retirement could provide the fundamentally the biggest change since auto enrolment (in 2012),” says Sophia Singleton, head of DC at XPS Group.
“It’s going to be transformational, for DC savers and how people use their money.”
Singleton goes on to explain that while pension freedoms laws passed in 2015 were welcomed by the industry, opening up options beyond annuity purchases, defined benefit savers rarely complain about the rigidity of their guaranteed income.
“What is key about guided retirement is the fact that it’s focusing on providing an income for life, which is really important for the sustainability of the pension system. It’s also what most people really need and want in retirement,” she says.
While it may raise eyebrows to some that the solution has taken no less than 11 years to come to fruition since 2015, Webb, who was pensions minister when the pension freedoms legislation was passed that year, is keen to explain why it may have taken so long.
“It would have been very hard the morning after pension freedoms to have guided retirement in place on day one.
“It takes time to consider what the right sort of guided retirement might look like, and where it can be different for different schemes. This was never going to be a quick process, and in a way, early on it didn’t matter too much because to be honest, most people with small pots were just cashing them in. The need for guided retirement grows as pot sizes grow.”
In 2015, the amount of DC assets in the UK amounted to approximately £324bn, according to the Pensions Policy Institute. As of 2024, it was £650bn and is projected to reach £1.3 trillion by 2044.
One key part of the legislation regarding guided retirement is that relevant communications must be conveyed to members in ‘clear and plain language’, a consistent challenge for what can sometimes be a complicated and opaque industry.
Anne Jones, a senior director for retirement at WTW, says: “Defaults are there to help members who basically are refusing to make a decision. But what’s really important is knowing that a default won’t be right for everybody.
“So we’re going to be helping members design their defaults, and work out what’s right for them, on potentially more than one default in some cases. The most important thing is going to be the member support framework, and I think that is what will be that that will dictate success or otherwise of guided retirement.
“Obviously we know that it won’t be right for everybody, and it will be a case of making sure that there’s education and tools.”
Retirement collective defined contribution (RCDC) has also been proffered as a solution to the issues that were first raised with pension freedoms, namely through the structure’s creation of collective fund with a target income, though importantly not a guaranteed income as provided via DB.
Steve Leigh, associate partner at Aon, speaks of how CDC can complement guided retirement: “The good thing about both retirement and workplace CDC is it actually takes all the difficult decisions away from the individual.
“Behind the scenes, whilst the design of CDC might be quite complicated, it’s not the individual who needs to be concerned about that. There are experts in the background working out the right way to invest the money.”
Leigh also believes that the intertwining of elements such as CDC and guided retirement more generally will force pension schemes to look more closely at plan participants, with a view to figuring out what is the best solution for members.
This is all of course an extra burden of duty for trustees and raises the prospect that guided retirement will be yet another catalyst for the consolidation of smaller schemes unwilling to take on further responsibilities.
There is even the possibility that without adequate checks and balances, there could be severe negative blowback if guided retirement options don’t perform as anticipated, with members not receiving the level of retirement income they had expected.
Webb, who is now a partner at consultancy LCP, says: “The answer with trustees is as always proper process and due diligence. This means considering a range of options, because often the challenge to a trustee would be if a decision was made carelessly or without taking proper advice or it was done sloppily.”
Webb also argues that it becomes more imperative for trustees to be aware of further details about a participant before they enter into guided retirement, such as home ownership and life expectancy.
To date, much of the focus on key parts of the Pension Schemes Act has been on mandation, the scale test and the new value for money framework, but guided retirement carries the possibility of being the single most significant element of this wide-reaching piece of legislation.
Even if the impact on areas such as trustee governorship remain up for debate, it will still have a deep impact on member engagement, savings approach, and an overall understanding of pensions. Whether it can solve this nastiest of all problems in decumulation remains to be seen, however.
