Alyshia Harrington-Clark , Policy Lead: DC, explains the thinking behind the PLSA’s DC decumulation recommendations.
Freedom is an attractive concept. We’ve come to expect freedom in almost all aspects of our daily lives and, rightly, question any restrictions that don’t seem legitimate, fair and reasonable.
In 2015 savers were ‘freed’ as, suddenly, they had a multitude of new retirement options to choose from. For some, this felt like a liberation from the constraints of the previous regime, but for many others it made their retirement choices far more complicated than they had ever imagined.
We firmly believe that the pension system should work for those who don’t know much about pensions, and don’t know where to go to seek help, as well as for those who have detailed plans and are confident about the decisions they take. Our recommendations seek to bridge the gap between using inertia to get people into pension saving, and the complex decisions they are required to make at retirement – in order for everyone to achieve a better income in retirement.
As you’ll no doubt remember, prior to the introduction of the pensions freedoms, regulation required most DC savers to purchase an annuity with their accumulated pension savings. This was intended, in combination with the State Pension, to provide them with an income for life. The liberalised regime introduced in 2015 allows people to access their savings in a variety of ways, namely by purchasing an annuity; by getting an adjustable income (flexi-access drawdown); by taking cash in chunks (uncrystallised funds pension lump sum); by cashing in the whole pot in one go; or by mixing two or more of these options. Ninety percent of pension pots moved into annuities in the decumulation phase.
Intuitively, it seems fair and reasonable to give savers maximum flexibility to decide how to access their hard-earned pension savings. This can enable savers to make choices about their short- and long-term aims, and also provide them with the level of income they need in retirement.
Evidence suggests that the freedoms have had a dramatic effect on the retirement market. Savers have moved away from annuity products and now tend to favour flexi-access drawdown. By June 2018, the FCA reported that twice as many pots were moving into drawdown than annuities, and 2019 figures suggest that the downward trend in annuity purchases has continued. The total value of flexible withdrawals has risen steadily, and now exceeds £35 billion.
However, in practice this means that the reforms have served to accelerate the trend of transferring risk from institutions to individuals. It’s becoming clearer that the excitement generated by the freedoms has, in many cases, not so far been matched by good outcomes for savers. We’ve spotted an opportunity to act now to address these risks, and shape the landscape for a better future.
Too much of a good thing?
The current retirement market requires individuals to make decisions about complex products that entail different levels of longevity and market risk. Of course, the best informed and most motivated savers will, at the very least, seek guidance from Pension Wise and, perhaps, regulated financial advice. However, evidence suggests that there is a significant guidance/advice gap. For example, the Money and Pensions Service estimates that there are currently around 75,000 to 100,000 people accessing DC pension pots worth £10,000 or more, without regulated advice or guidance, each year.
As a result of these trends, risks that were previously borne by insurance companies are now increasingly borne by individuals. No regulatory regime can protect people from all the risks inherent in retirement. However, the freedoms opened the possibility of people running out of money in later life, of their income being severely affected by market volatility, and of scammers taking advantage of them as they continue to make decisions long into their retirement. Clearly these risks are serious, and we believe that more needs to be done to mitigate them. This is especially important before people come to rely exclusively on DC savings to fund their retirement.
The inertia gap
One of the major challenges to achieving good outcomes for savers at retirement after the freedoms is their low level of engagement with pensions. The most successful pensions policy initiative in a generation, automatic enrolment, relies on the power of inertia. Savers are highly unlikely to transition seamlessly from being inert accumulators to becoming active and informed at retirement. There needs to be a bridge for savers to safely traverse this gap.
Improving DC savers’ retirement outcomes is at the centre of the PLSA’s policy thinking. In Hitting the Target, the 2018 report which set out the PLSA’s vision for achieving retirement income adequacy for all, we recommended that the government should reform the freedoms to deliver what we called ‘guided at-retirement decisions’.
Earlier this year, we deepened and refined our thinking in this area via a three-month Call for Evidence on DC decumulation. We engaged with stakeholders from across the industry to refine its proposals and take account of emerging evidence in the sector. We’d like to take this opportunity to thank our members for such a great response – we received a superb set of written responses from across the sector, and had many excellent thought-provoking roundtable discussions.
We launched our final recommendations on DC decumulation at the Annual Conference in mid-October. In essence, our proposals would require schemes to signpost savers to a preferred decumulation solution, be it in-house or via a third party. This is in line with what we know about consumer needs. For example, recent research by the Defined Contribution Investment Forum found that 77% of people want their pension provider to offer them a ready-made solution. Our proposals would help to satisfy this demand.
We believe our new approach reflects the level of engagement savers actually display rather than the level we would like them to, and mitigates the risks they face. To get the most out of the freedoms, we need to help build the bridge for savers between the inertia at the beginning of their journey that helps them on the path to success, and the complex choices they are required to make at retirement as they continue their journey into their future.
Laying a solid foundation
To deliver this solution across the pensions market, we believe the government should bring forward legislation to introduce a new statutory obligation for schemes to support their savers with their decumulation decisions. This is important for savers, even if it is ambitious, especially in the times we live in. The new statutory obligation would consist of three key elements – member engagement and communication, signposting to products, and governance – each of which would have key minimum standards for the industry.
We believe that introducing new legislation would manage the risks for both savers and schemes in delivering the best support throughout the journey to retirement. It would address some significant barriers preventing schemes from taking action, including litigation, that can arise when providing additional support such as signposting. In practice, schemes’ selection and review of a preferred decumulation solution would harness the duties and responsibilities of trustees and bring them to bear to demand products and solutions which accord with a set of minimum product and governance standards.
Our solution leaves room for people to choose alternative options should they wish to do so, and member consent would be required before any action took place. To facilitate this, as part of the appropriate communications to savers in the run up to and during retirement, schemes would provide members with key information and prompts to seek guidance and advice. This would dovetail with the new DWP policy initiative to develop a stronger nudge to pensions guidance.
We believe this proposed legislative framework would protect savers’ freedoms and enhance them, by providing more support coupled with more innovative solutions. We expect the requirement for schemes to offer a preferred decumulation solution to stimulate demand-side pressure on behalf of savers for much-needed innovation in the retirement market. Crucially, this innovation would benefit from the institutional experience and buying power of trustees and schemes, which would go a long way to delivering sustainable solutions for many more savers in the future.
We’re working now to make our recommendations a reality. I believe we should, in all aspects of our lives, fight for the right kinds of freedoms. But we must also do what we can to protect those that otherwise risk facing the worst outcomes. Sometimes bridging the gap to a better future is not quite as daunting if we all play our part.