Reliance on defined contribution (DC) plans for retirement income is growing by the year, but the industry is only just starting to develop clear strategies for how non-advised retirees can draw their pensions.
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But there are several obstacles to overcome and complexities to navigate before an optimal solution is developed, with the integration of private markets and alternative investments into decumulation propositions, diversity challenges in product design, and behavioural lessons to be learnt so that members can be guided towards the most suitable products. That was the conclusion of delegates at a recent round table on meeting the DC retirement challenge held by Corporate Adviser.
The problem flows from the complexity of the decision faced by individuals at retirement, and the many varied factors that influence the sorts of choices they might make.
Schemes and providers have no way of knowing what other assets, pension or otherwise, an individual might have, whether they own their home, or the financial circumstances of partners and dependents, their outgoings and attitude to risk, and a host of other factors that influence what a good outcome might look like.
The King’s Speech signalled the government’s intention to require schemes to offer retirement income solutions, an obligation that will be included in the Pension Schemes Bill.
But with some time still to go before formal rules are drafted, the DC sector is starting getting its house in order – and some argue it may even end up offering a solution that can offer a serious challenge to the private wealth management world.
Crystallising event
Delegates debated whether schemes would tend to opt for a single ‘go forward’ income option in retirement, or whether retirement income solutions would force the individual to make a decision.
Esther Hawley, head of retirement proposition at Standard Life said: “From my understanding, the DWP were talking about requiring hard defaults, where people go into decumulation without making an active decision. But that gets very difficult when the decumulation involves a crystallisation of your benefits from a tax perspective – to assume or impose a personal tax decision on an individual. There’s a lot of detail that needs thinking through and working out before this lands.”
Jeni Flanagan, principal at Barnett Waddingham agreed: “I think we need something much softer than a hard default, and that comes back down to the individual. It is important to have that inbuilt flexibility, the option to make choices later on. So not locking in per se but actually being able to review choices. But that’s got to be underpinned by education.”
Scott Kendrick, partner at Isio agreed on flexibility. He said: “There’s a real resistance to annuities – the irrevocability is one of the key barriers. So I’m really interested in this design, which says actually you don’t need to trust it all the way, we’re going to introduce some options for you, and as long as you can secure your essential needs.”
Jacqui Reid, partner at Sackers, suggested the government’s idea of a hard default could evolve into some form of minimum income guarantee. “This could be where we go – mandating a hard default, almost like where we were 10 years ago.”
Surviving partners
For people on modest pensions, traditional financial planning points to ensuring basic expenditure is covered by secure income. But while pointing people to annuities to support this seems sensible, a key diversity issue emerges for non-advised guidance, that of the complexity of dealing with single or joint-life annuities without knowing what relationship an individual might be in.
One delegate cited an experience of a family member who had taken a single life income, died two years after retiring, and was survived by his spouse for another 36 years. She had no private pension at all.
Hawley said: “To be frank, this is quite difficult, and there is definitely more thinking the industry needs to do.”
Flanagan said: “Apathy reigns, so if you don’t present people with the options, they’re just going to go with single life. I struggle with the moral responsibility here. I think the default to single life is quite dangerous here – we’re talking about 17 years of pension gap [between the genders].”
Reid said: “It’s not helped that it’s been kicked into the long grass by the government. Because if you have three part time jobs under £10,000, you don’t get any contributions and that makes this issue worse. There are things that the government should be doing in this space.”
Separation anxiety
Standard Life senior investment manager Garry Latimer pointed out the complexities around not only whether people were in relationships, and what their significant other might have in terms of assets, but whether that relationship was likely to change in the short term. He said: “For people in their late 50s early 60s, we now have something of a theme in that it is probably the peak age for divorce rates. This really does influence the financial planning and decision making that we are seeing from members.”
Reid said this highlighted the scale of the challenge around making assumptions about people, and that GDPR rules made this harder.
“How do you go about segmenting your engagement in a way that doesn’t create the wrong assumptions. What data do you use to base these assumptions on, and what is personal and what is sensitive data?,” she said.
Kendrick agreed, adding: “There’s a lot of evidence that when you’re trying to segment a population, if you get that wrong and somebody feels they’re being boxed in, they can have a seriously negative, disengaged reaction to that. It has to be done really, really carefully because we may be trying to do the right thing, but actually we can end up turning people off.”
Hawley pointed to the research done for the FCA on targeted support which showed members didn’t like phraseology such as ‘people like you’, or ‘people in your circumstances’, because they felt there was a negative subtext to the assumption. “The other interesting thing in that research is they thought we have a lot more data about people than we actually do.”
Other complexities to be navigated when building non-advised targeted support guidance pathways include issues around benefits, disability support and whether the individual is a homeowner or likely to be renting in retirement. For this latter group, the interaction between how pension is drawn and how much housing benefit is received is complex.
Diverse challenges
Other diversity factors also present challenges for the industry when attempting to guide retirees to good outcomes. Flanagan said these include issues such as neurodiversity, different educational backgrounds, gender, ethnicity, income group. “These have to be factored in through engagement but also through design. And there is the areas of Shariah investing to consider,” he said.
Latimer added: “The industry is responding to the Shariah challenge [in accumulation]. But a lot of people invest in a single fund strategy which is either an equity-based or sukuk bond model. They are pretty concentrated and risk on, so volatile. We have some options for this group and this is something we are going to unveil shortly. The next challenge is what about when these members start to take income? This is a massive theme for the year ahead. “
Targeted support
Delegates agreed that clarification of what targeted support actually is will help providers give better member outcomes. But there was some concern that the new rules might be limited to FCA-regulated contract-based arrangements and not apply to occupational schemes governed by trust law under The Pensions Regulator. Hawley said: “At the moment, the way the FCA has set out the limits of targeted support, it says it applies to contracts. It would be unfortunate if that is where we end up, because targeted support has the potential to be really powerful applied across both regimes.”
Grove Trustees director Gurmukh Hayre pointed to the consultation as an avenue for the industry to make its case. “It’s for the industry to feed back and say, if you do this, you’re just solving a problem for 40 per cent of the market. It has to apply across the board,” he said.
Workplace v retail
Hayre said a key priority for trustees and employers is making sure retiring members move into products that are not only suitable for their circumstances, but also offer the sort of institutional pricing they have benefited from in accumulation.
Latimer said: “There are a number of reasons why people may go to retail. A lack of access to flexibilities is part of this and also the advice piece.
“I did a comparison recently for a senior employer who asked how we compared with wealth managers. Like all of the [retail financial services provider] names that have been trotted around, the performance was horrendous. If you looked at a tight range of workplace providers versus the private wealth market, you would be horrified at the results because there is not the same pressure to deliver returns in quite the same way. An absolute return is a good thing in the retail market because you do not get questions from the client.
“If we can help members from own trust bridge to something that actually sets them on the right path, once they have clarified what their medium to long term ambitions look like, that’s got to be a better thing than doubling or tripling their charges, and potentially having an investment strategy where you do not have the governance of Gurmukh and his [trustee] colleagues and peers in the industry.”
LCP investment partner Sam Cobley argued that workplace was actually in a strong place versus retail, as his experience of advising private wealth houses had shown him.
He said: “They are worried about £150,000 to £200,000 pots. There’s a significant minority of these – the FCA said 25 per cent of people with £250,000 managed their money on a non-advised basis. They’re worried that will increase if workplace solutions are better. They’re worried about kind of losing the bottom of their client base. I’ve done a couple of sessions in terms of looking at the fee differences and the solution differences being developed, because they’re interested in how they can backfill to make sure they retain that bottom section.”
Workplace fightback
Latimer argued that the new tools available to workplace decumulation defaults meant they could offer something new that went beyond the traditional alternatives of annuities or historic forms of drawdown.
He said Standard Life planned to launch a new opportunities style default in the second half of this year. This would be a genuine high conviction fund, adding that while all the focus on private markets had been the growth phase illiquidity premium, there was also a new opportunity in decumulation.
“We have we have a trajectory where we have fewer complications [in decumulation]. We’ve got clearer member outcomes where we want a balance of flexibility and guaranteed income. It doesn’t need to be as blunt as to target buying more gilts. It can be a lot more sophisticated with the right private market asset components.”
Cobley agreed. He said: “A to-and-through retirement piece is actually very easy if you’re landing people in drawdown initially, because you can just run on the assets, and you can use private markets.
“I think master trusts have been slow compared to trust-based schemes. We’re doing things like single sleeve private equity funds and then private credit funds with schemes. But that is where master trusts will have an advantage with their scale in terms of being able to do a single sleeve allocation, because at the minute most people are doing a multi-asset solution, but they will look to expand that at some point to do single sleeve. They’ve got the scale to use private markets much more efficiently through the glide path and post-retirement.”
Non-advised decumulation journey design is in its infancy, but with the right components and institutional pricing, the opportunity to develop a market-leading proposition clearly exists.