What does the data tell us about the way defined contribution (DC) savers are currently transitioning into retirement?
The headline figures show that 85-90 per cent of retirees are fully cashing out, reflecting the small DC pots of today’s retirees and their dependence on defined benefit (DB). But we estimate around half of our members haven’t accessed their pension by the age of 65, around a quarter by age 70 and even at 75 a fifth haven’t touched their pot. Digging deeper into the data we also get a glimpse of what the future may hold. For those with pots over £150,000 who have accessed their retirement savings, 84 per cent took income drawdown in 2021, up from 64 per cent in 2015. This may be an indicator of how the market develops as DC becomes the principal retirement income vehicle.
How are scheme members withdrawing their cash?
At the present, most are looking at their DC pot as a cash fund, taking it in one or a few lump sum payments. But we have noticed that over the last few years people are starting to spread these withdrawals over an increasing number of payments, particularly those with bigger pots.
How significant is longevity risk to drawdown investors?
Longevity risk is arguably one of the two biggest risks faced by retirees in incomed drawdown, the other being investment risk. ‘Will I outlive my savings’ and ‘will I be punished by the markets’ are known to be the two imponderables that challenge drawdown investors.
What is less well known is the extent to which these risks change with time. Our modelling shows that at age 65 investment risk and longevity risk are about equal, in terms of their impact on the risk of running out of money. But at age 75, longevity risk is five times greater than investment risk, while at age 85 it is 20 times bigger.
This means income drawdown gets increasingly risky in older age, an achieving the equivalent of the income you could get from an annuity also gets harder.
Our modelling shows that for a drawdown investor looking to replicate the income they could get from an annuity, the chance of failure increases with time. At age 65 per cent there’s a 20 per cent chance of failing to match an annuity income, but this rises to around 50 per cent by 90 and continues to rise after that.
What impact does cognitive decline have on the suitability of drawdown as a later-life solution?
Being an income drawdown investor requires a level of engagement that becomes increasingly difficult to maintain because of cognitive decline.
The FCA’s Aging Mind report found ‘deciding what to do with my pension pot’ at the very limits of its map of the complexity and familiarity of the different financial decisions asked of people.
Research has shown that even relatively simple mathematical problems become challenging for many retirees as they get older. Asked to divide two million by five, half of people age 60 got the right answer, a survey found. Amongst 90-year-olds, just one in 10 got the right answer.
With so many challenges to drawdown, do we need new retirement solutions?
No. The products needed to deliver decent retirement outcomes already exist – an annuity taken later in life can address the challenges that emerge for drawdown customers as they get older. The challenge is designing choice architecture, nudges, education and guidance that can direct individuals to the right products at the right time at the key points in their decumulation journey. And this architecture needs to be inclusive and reflective of the diverse needs of all savers.
How does guidance need to change?
We need to create guidance pathways that speak to all members of the population in language they understand, about the issues they face – for example ‘what is the chance of me having enough income until I die’. We also need people to revisit tools on a periodic basis, which means boosting engagement. And behind this guidance, there needs to be a nudge towards the products and funds that are most likely to be suitable for the individual at a particular point in time. We advocate the introduction of personalised guidance to give providers and trustees a safe harbour to support members maing informed decisions about retirement.