In this week's Technical Comment, Scottish Life's Fiona Tait looks at how pension schemes can communicate with their members to help them achieve a secure and sustainable retirement income.
The chancellor recently sought to address this issue with his Budget promise of a ‘guidance guarantee’ for defined contribution savers at the point of retirement, but this does not address how much people need to save before they reach that point.
Key points
• Help members understand the need to convert their pension fund into retirement income
• Provide information to help them decide how much they need to save in order to retire at the age they want
• Help them to understand the irrevocable decisions they will be making when they do take benefits
While there are well-documented criticisms of the at-retirement process, the main failing is usually failure to save enough in the first place.
For many, the capital value of the pension fund could be the highest saving pot they have ever owned, and it is difficult for them to assess its true worth.
One useful measure is a comparison of projected retirement income with current salary – the so-called replacement rate. Illustrations of life expectancy for relevant age groups may also help demonstrate how far their fund may have to be stretched.
The provision of information should be a consistent and engaging process. The annual review pack should actively assist the member to easily check whether they are on track to retire when they want, on an income they can live on.
Key retirement decisions
As a member gets closer to taking benefits they may want to protect the savings they have already made. While they will want to avoid suffering last-minute losses which would be difficult to recover from, derisking too early will reduce the potential for growth.
Communications at this point should include information designed to help members decide on the rate and period of time which is likely to suit their individual situation, starting no later than five years before their planned retirement date.
When discussing product options it is essential to focus on the member’s potential needs, particularly for income. The ability to take the entire pension pot as cash from 2015 does not change this. A pension’s primary purpose is to provide replacement income when people retire.
Many older employees work part-time, which may require a phased approach to taking retirement benefits. Make sure your members are aware options exist that can provide partial access to their savings and the flexibility to alter the amount of income requested over time.
Annuity purchase is more likely to be suitable when the member is fully retiring. Members must be clear that choices made at this point cannot be reversed, although some choices can be left open.
Assuming no other decisions have been made at this stage, communications inviting the member to choose how their retirement income will be paid should be sent out at least six months before the projected retirement age.
Standard illustrations usually show level, single-life annuities, which provide the highest possible income. As a result, most retirees will take this option even though it is not necessarily suitable for their circumstances.
A short questionnaire could help members to identify whether they are likely to qualify for enhanced rates, whether they need to provide for dependants in the event of their death and the options available for inflation-proofing.
Good practice might also include descriptions of the possible consequences if these options are not taken up.
If an annuity is selected, the final decision is whether to take the open market option. We know from the Financial Conduct Authority’s recent review that by taking this option 80 per cent of annuitants could get a better deal than they do now, and yet many do not take advantage of it.
It is crucial, therefore, for members to be shown not only that they can shop around, but also how they can do it.
The Budget commitment to provide “free, impartial, face-to-face guidance” is undoubtedly helpful – however, such guidance is usually generic in nature.
Common themes, such as increasing longevity and the effect of inflation, can be covered by guidance – but access to financial advice throughout the whole retirement process would be better. If this is difficult to deliver on an individual basis, it might be possible via employee meetings that members are invited to attend at specified ages or lengths of service.
Fiona Tait is business development manager at Scottish Life
