When pensions freedoms were introduced in 2015, there were a significant number who were concerned about the bold new policy, fearful of the potential for unintended consequences.
During the intervening six years there has been plenty of lively debate and discussion from those on opposite sides of the freedoms debate but how much of this has been based on real evidence?
Enter Ignition House, the consultancy, that has pursued a ground-breaking behavioural study since 2015 into how pension savers have responded to the new choices in front of them. This research, which has been sponsored by The People’s Pension and asset manager State Street Global Advisors, focuses on those over the age of 55 who will be reliant on pension savings of between £30,000 and £250,000 to finance their retirement.
As defined benefit pensions disappear, exercising choice with a pension pot in this range will increasingly be the new retirement normal for most people from the defined contribution generation.
The latest chapter of New Choices Big Decisions, which centres around 50 savers who had either finished their careers or were very close to reaching that milestone has discovered that a significant number of the participants in the study are sleepwalking into retirement and are facing a worse quality of life in later years than could have been the case if they had been guided by a scheme or an adviser.
This is partly because designing an effective pension retirement product for any individual is a complex challenge and requires skills drawn from actuarial science, economics, medical science as well as investment knowledge. However, this process is made even more difficult because it also requires people to overcome a set of behavioural biases which make it very difficult to grapple with the risks, even when they have the required skills.
These risks are laid bare in the New Choices Big Decisions report and evidence includes examples of people being scared of planning for retirement as they don’t want to discover
the ‘truth’ of how much income they will have in retirement, their underestimation of the risk of outliving savings which are drawn down based on the assumption of an average life- span, and, their lack of appreciation of the effects that even a relatively low-level of annual inflation can have on the purchasing value of their savings over time. In addition, the typical saver follows the path of the least resistance
– they won’t leave a product or change a drawdown withdrawal rate once they have signed up even if it ceases to be appropriate given changing market circumstances or turns out to be poor value.
The report highlights that there is a gaping gulf between the assumptions made by the policy makers behind pension freedoms about how people would behave and what actually turns out to be the behaviour of the man and woman in the street. The assumption that pension scheme members will rationally plan for retirement does not fit the clear evidence that savers are scared of planning for retirement as they don’t want to grapple with mortality. Even where they are obliged to think about retirement, they significantly underestimate how long they will live for and hope, without being sure of its value that the state pension will be enough to sustain them if their savings were to run out.
Ignition House suggests a guided retirement product would be best suited for most people and that pension schemes need to do much more to help members find products which match their retirement risks.
For most people, a pension needs to aim to provide an income throughout the whole of an individual’s retirement and should not be treated as just another savings product. As automatic enrolment workplace pensions mature and those people reliant solely on DC pensions start to retire in large numbers, policy makers and providers need to be ready to ensure that DC pensions are the bedrock of a decent retirement. There is little point shouting about the huge success of automatic enrolment and its 10 million plus savers if these individuals are destined to run out of cash and forced
to rely solely upon the State Pension in their later years.
This report fills a big gap in our understanding of how people are exercising pension freedoms and spells out that retirees with a defined contribution pot need to be guided to good outcomes. Freedom not to follow this guidance also makes sense: there will still be large numbers of people with alternative sources of retirement income other than their defined contribution pot and so they should be free to use the latter for other purposes.
The debate in the 2020s should no longer be about whether or not freedoms are a good thing – they are here to stay – but rather about how policy makers and the industry work together to ensure that a practical retirement solution should fall on either pension schemes or advisers and not perplexed individuals.