Now that the new pension freedoms are in place, we face the challenge of making sure that the products, guidance and advice are available to enable individuals to make the most of the new regime.
It is clear that the flexibilities are valued by scheme members. But members also say they will not have a firm view of how they will exercise them, and what they will do with their assets, until they are close to retirement.
Only 16 per cent expect to have a firm idea more than five years ahead of time, with 46 per cent expecting their plan to become clear within two years of retirement.
This uncertainty reflects in part the ‘new retirement’, whereby retirement is more fluid in its timing and more gradual in nature.
Our research tells us that only 25 per cent of members know the year that they will retire. As many as 44 per cent feel unable to give a five-year window within which they expect to retire.
Rather than having a pre-set date on which they will stop work and enter retirement, individuals expect a gradual process where work gives way to more leisure time and the timing is more driven by circumstances. Increasingly, individuals expect to work part-time in retirement, through either financial necessity or a desire for purpose and social interaction.
According to our research, income drawdown is the most popular method members expect to use to access their pension funds, with 41 per cent of respondents expecting to keep their funds invested after retirement.
That does not mean the other options do not appeal to some members. We also found that 21 per cent of members plan to take their savings as a cash lump sum at retirement or in the early years of retirement, while 15 per cent plan to buy an annuity and 23 per cent do not know what they will do.
Flexible income drawdown approaches are popular but it is clear in our research that most individuals do not want to be forced to make complex investment decisions to benefit from the flexibility.
That view chimes with in-depth interviews and focus groups conducted for the Pension Policy Institute’s (PPI) Transitions to Retirement report, which found most members wanted
to leave the retirement investment choice to the “experts” and were comfortable with the idea that there would be a default investment option in decumulation, as there is in the
accumulation phase.
That default strategy needs to provide sufficient investment growth to sustain an income through retirement, while protecting against inflation and managing downside risk.
Downside protection is important because of the dangers of sequencing risk; drawing income from a portfolio that is falling in value can lead to very poor outcomes.
The appropriate approach is likely to involve some form of multi-asset fund, with dynamic asset allocation, or other volatility management features to manage risk. It is more important to create an efficient portfolio with a good balance between risk and return than to focus explicitly on income-generating assets. Most drawdown strategies require some consumption of capital.
A retirement default strategy also needs good governance and to provide value for money. Part of that governance is ensuring that the strategy evolves as markets and member needs change through time. The adviser has a role to play in this but the investment strategy should be future-proof too.
Finally, the fact that members value the flexibility of income drawdown does not remove the challenge for them of making retirement assets last a lifetime.
Many of the participants in the PPI research underestimated how long they could live. They had a fairly good grasp of average life expectancy but failed to appreciate how many people would live to advanced ages.
There may be a role for combining secure, annuity-based income with drawdown in order to manage longevity risk. This could be a mix-and-match option where some secure income is used alongside flexible drawdown. Alternatively, a deferred annuity could be built into the strategy to provide a backstop income from age 80 or 85.
Nest is consulting on such an approach and the ideas seem worthy of further consideration.
