There are concerns that the government may have put on hold reforms that would require pension schemes to offer retirement income solutions to all savers.
This was one of the issues highlighted at a recent roundtable event, to discuss the key findings of Corporate Adviser’s Workplace Pensions into Retirement report.
View a PDF of the round table supplement HERE.
This report identified a clear lack of consistency in what providers currently offer at retirement, in terms of proposition and functionality, with marked differences between contract-based and master trust schemes.
Consultants and providers attending the event agreed that this needs to be addressed in order to avoid ‘value destruction’, as savers can significantly damage their longer-term financial security by making sub-optimal decisions about their pension savings as they move into retirement.
LCP partner Sam Cobley said this issue seems to have dropped off the government’s pension reform agenda, after a wave of pension reforms were initially proposed in the King’s Speech at the start of this parliament.
“Previously there was some momentum around this issue, but it is my understanding that these plans are on ice.” He pointed out that the government appears to have other pension priorities, specifically encouraging consolidation across the workplace market to encourage greater investment into productive finance and the UK economy.
Many of those at the roundtable felt this was a missed opportunity to introduce reforms that could make a significant difference to many pension savers.
But in the absence of more immediate regulatory action on this front, those attending agreed that the industry has a responsibility to develop modern retirement income solutions that can address the various needs of today’s savers.
So what might a decumulation solution look like? Cobley said that it is clear many providers are developing solutions that essentially offer drawdown in the early years of retirement with an annuity purchase around 80 or 85. “There are nuanced solutions around this but many are working to a similar theme,” he said.
Other consultants highlighted different approaches in the market. Aon partner Jit Parekh said he welcomed this. “Providers are engaging and looking to solve these problems. The fact there are different approaches is good, because you want people to have choice, and members will have different circumstances and situations. We don’t want to impede innovation at this stage by creating a herding culture.”
Gallagher benefits consulting director Jason Cannon pointed out that there was significant innovation in this area at present: “I think I’ve seen more innovation and change in this space in the last year than we have seen in the previous decade.” He added that this was long overdue, given the various problems that have been created first by the Retail Distribution Review (RDR) pricing many out of the advice market, and then by the Pension Freedom rules, giving people choice but significantly more complexity around retirement decisions.
Retirement investment strategies
The panel debated what retirement income investment strategies might develop, particularly if this is modelled on a drawdown structure in the early years. Does the industry need to offer ‘safeguards’ to reduce equity volatility and ensure savers don’t deplete their funds too early?
Cobley agreed that some form of smoothing might work, but said it was unclear how this might operate, particularly in a workplace solution where individual members are not necessarily getting advice. Redington senior vice president Russell Wright said: “I think members like the idea of smoothing but don’t like not understanding how their investments work, which is why with-profits has fallen away.”
Many identified a need for effective asset diversification to reduce volatility — a lesson some said that is at risk of being overlooked in the more recent benign investment climate, where equity-only strategies have outperformed.
Legal & General head of DC Rita Butler-Jones said diversified growth funds can help manage investment risks, particularly as people approach and move into retirement. “If you are at a certain age seeing your fund drop 20 per cent can be a bitter pill to swallow, when you don’t have time on your side to rebuild gains.” She added that taking a regular income from a fund post retirement can also exacerbate losses.
Wright said he would also like to see providers take more of a lead when it comes to promoting sustainable withdrawal rates. There was scope to offer capped drawdown products, he said, which set a maximum withdrawal rate. “There’s nothing stopping providers offering this. If members want to withdraw more they are free to move into a flexible drawdown product, but it would set some benchmark which many would adhere to.”
Cannon agreed this could be useful. “In many ways the industry has gone backwards. I’m old enough to remember the government actuary department setting minimum and maximum withdrawal rates for drawdown.”
Those at the event welcomed the additional flexibility savers have today, but agreed such parameters would be useful. However, most were doubtful whether a government department would set such limits, even as guidance, particularly as a sustainable withdrawal rate would depend, to a certain extent, on individual circumstances. It could also open the floodgates to future complaints and compensation, should this guidance prove incorrect, due to poor investment conditions or increased longevity.
Butler-Jones said that under current legislation, providers are similarly unwilling to set such a benchmark, even on a voluntary basis. “There’s the danger this is viewed as advice, as essentially what you’re saying is that this is a sensible amount to withdraw from your pension plan. You’ve no safe harbour as a provider, and no idea really what other savings or pension pots a person might have.”
However, she added that changes to the advice/ guidance boundary could enable providers to give more tailored support and information to pension savers on this issue — and at the very least allow them to flag up warnings about unsustainable withdrawal rates.
Flexible tax-free options
This isn’t the only area where consultants would like to see providers give more guidance to savers on retirement income options. Wright pointed out too many people take their full tax-free cash at the earliest opportunity, even though this may subsequently just sit in a bank account.
Butler-Jones said Legal & General has done significant work to highlight the potential dangers of such action. But she said that providers’ hands were again tied when it came to offering more personalised guidance to savers on this issue – due to the current rules around advice.
Many said this problem has been exacerbated by frequent political tinkering with pension rules. For example speculation that the Chancellor could remove or limit tax-free cash caused a significant jump in the number of savers crystallising this benefit ahead of the last Budget. Part of the problem Wright says is that tax-free cash is the one element of pension planning that resonates with savers. This can help with engagement but it can also lead to some rash decision-making.
Mercer Marsh Benefits head of workplace savings David Croker says: “There’s a lot of people who just want to get their hands on the tax-free cash and park it, because they are worried they may not be able to do so at a later point.
“There needs to be better education and understanding around this, so savers know they don’t have to take this all at once. But savers are going to need a huge amount of help to ensure they can plan their retirement better.”
Beyond changes to the advice/ guidance boundary, could the design of retirement products and proposition help? Wright certainly thinks so.
“I’d like to see more providers offer drip-feed drawdown, giving people the option to take just part of their tax-free cash.” He pointed out that without effective communication about this functionality, it does not tend to be widely utilised.
Wright added: “One practical thing that providers could do is to stop offering Ufpls. At the moment a number of providers offer Ufpls and drawdown. Many savers get confused about the difference between the two and Ufpls appears far simpler so they just take their cash in one go. It’s a very subtle difference, but if providers stopped offering Ufpls it might encourage people to start thinking about their longer term plan.”
Third way options
One topic under discussion was whether providers will start to offer retirement-only CDC in the near future. Corporate Adviser’s Workplace Pensions into Retirement report found that eight of the 21 providers surveyed said they could see themselves launching a scheme in the next five years — including Nest, the UK’s largest master trust provider, by number of members.
Butler-Jones said that CDC had clearly risen up the agenda this year, with the launch of the Royal Mail CDC. She pointed out this is an accumulation and decumulation plan, which has the benefit of a 20 per cent employer contribution. She said L&G is also now considering how various CDC options might work in the workplace market.
Wright said it is clear the Labour Government supports multi-employer and retirement-only CDC, with both being seen as an effective way to pool longevity risk and introduce greater certainty around retirement income for members.
But he said one of the potential drawbacks was its complexity. “Members don’t like not being able to understand how their investments work. I think this is why CDC might struggle.”
This view was echoed by NPF regional director employee benefits Martin Parish. “It’s certainly nice to have this smoothing, but is this the priority for members?” He said he thought the main priority for most people was control over their savings, reflected in the fact that drawdown and pension freedoms have proved far more popular than annuities in recent years. “People now have the attitude that it’s their money and they want to understand what’s happening with it. I think this trend will only increase with the next generation of savers, as they don’t like being told what to do with their money.”
But others argued that surveys suggested that people want certainty when it comes to retirement income, although ideally with a degree of flexibility. Cobley said that CDC offered other benefits, not least the fact it links contributions made during the accumulation stage to retirement income. “There’s some comparison here to DB pensions. Most people didn’t understand how the conversion factors worked, but they could see how they were building a pension income in retirement.
“There may be some benefits with CDC is terms of this type of communication. So if you save, for the sake of argument, £1,000 a year, this translates into a set increase to your retirement income — depending on the conversion factor used.”
However Emma Hadley, head of pensions for Howden Employee Benefits & Wellbeing said this might act as a disincentive, particularly for those with relatively small pension pots. “If you look at the size of some of the pots, for example with Nest, you might get a communication saying this will give you an extra £3.50 a month. It could actually undermine the whole principle and is potentially a reputational risk for some providers.”
Despite these challenges consultants said they could see the potential for retirement-only CDC, particularly if a major AE provider launched a version of this. Given Nest’s widespread distribution (around one in four workers has an active or deferred Nest account) Wright said there was clearly scope for it to become a “consolidator of choice”, although only if it can offer more functionality around retirement income options.
CDC is clearly one major area of innovation but Butler-Jones points out that providers have been looking at other areas too, including offering ‘multi-pots’ where savers split their retirement savings into core income needs — which may be annuitised — leaving pots for discretionary spending and a potential inheritance, which can be drawn on should people live longer than expected or investment conditions are more challenging.
Inheritance tax challenge
Pension providers have got used to adapting their proposition to meet new political priorities in what has been an evolving regulatory landscape in recent years. Alongside a renewed political focus on CDC and the review of the advice/ guidance boundary, providers are also looking at how Value for Money regulations and the Consumer Duty rules could impact product design in the retirement income space.
Parish pointed out that other tax changes may also come into play, particularly the recently announced budget change that will once again bring pension savings within the wider inheritance tax net.
He said he knows of a number of providers looking to embed international or UK bonds within their workplace pension platform by the end of the year to help those with more significant savings mitigate potential inheritance tax liabilities.
“As people accumulate more wealth I think there will be an increasing need to access some level of advice. Providers are trying to speak to clients, but as the rules currently stand they essentially have one hand tied behind their back.”
It is clear that when it comes to providers evolving thier workplace pension propositions, at retirement functionality and product design will be a key area of innovation over the next few years. Consultants remain optimistic that a raft of new options should help the next generation of retirees, who are likely to rely more heavily on DC-only savings make better decisions about funding a longer retirement.
