Trustees of the Caterpillar Defined Contribution Pension Plan have decided to change the scheme’s default fund to target flexible drawdown, as industry experts highlight the importance of looking longer term and communicating default changes carefully.
Between 2016 and 2017, 54 per cent of people chose a drawdown policy, compared with 35 per cent between 2015 and 2016, according to research by consultancy Willis Towers Watson.
The construction machine manufacturer’s DC default fund originally worked on the assumption that retiring members would want to buy an annuity, but following the introduction of freedom and choice in April 2015, a review was carried out.
Default options can’t be changed too often
Trustees of the UK DC scheme, which has 5,810 active members and 2,747 deferred members, acknowledged that “there has been a dramatic fall in the number of members buying annuities – not only in our plan, but across the UK”.
You don’t want to be chopping and changing your investment default on a regular basis
Mark Futcher, Barnett Waddingham
The trustees decided that everyone who was in the scheme’s existing default fund and more than two years from their target retirement age would be transferred into the lifestyle flexible drawdown option from August 29 2017.
People within two years of retirement will remain in the lifestyle annuity option unless they state that they want something different to happen.
Many schemes have reviewed their options to adapt to the introduction of pension freedoms. Mark Futcher, partner and head of DC and workplace wealth at consultancy Barnett Waddingham, said trustees need to “make sure that, if you are taking a decision, you think it’s actually reflective of longer term – ie sustainable – behaviour”.
“You don’t want to be chopping and changing your investment default on a regular basis, because of all the transaction costs you incur on doing so and mixed messages you’re giving to the members,” he added.
Communicate default changes carefully
However, David Snowdon, director of institutional DC solutions at SEI, said that “the beauty of a trust-based scheme” is that if there is a major new development in the world of annuities, for example, “you can actually go back and react quickly to that”.
The trend of DC schemes changing their default strategy is likely to continue, with many moving to drawdown, Snowdon said.
But trustees should be careful about the way in which they communicate this, he added.
“If you’re seen to be encouraging people to move from somewhere where you have guaranteed income for life – however low – to a default where you may well last a lot longer than your money… the communication of that is key,” he said.
Damon Hopkins, associate director of solutions at consultancy firm P-Solve, noted that the introduction of freedom and choice has presented a “conundrum for DC trustees, particularly given the relative immaturity of DC in the UK and that we’re only two years into arguably the most significant change to pensions in a generation”.
When looking at the suitability of a default, it can be helpful to look at decisions retirees have made since April 2015.
However, “it is not likely to be overly definitive, simply because of the relatively short period of time since the introduction of the flexibilities”, Hopkins noted.
Schemes play a guessing game
In some cases, few members may have retired from a scheme, so there is barely any information for the trustees with regard to reviewing the default.
Hopkins said trustees could consider the profile of their members. For example, they could look at whether members are high earners with large DC pots, which could mean that members are more likely to go into drawdown, purchase an annuity or choose a combination of both.
However, “some trustees may simply not be comfortable making a wholesale change based on these broad assumptions”.
Instead, trustees may decide to stick with what they currently have in place until they have gathered more information on member decision-making.
“Others may decide to engage directly with members to ask what their likely retirement objectives are,” he noted.
Another option is to structure the default so that it holds a mix of investments, which targets no particular outcome but ensures it is not wholly inappropriate, regardless of which withdrawal option a member decides to choose.
There is a risk that trustees try to create a default that fits each member and their specific needs perfectly, which is unrealistic, Hopkins said.
He noted that “trustees should work collaboratively with both their advisers and the employer to ensure they understand their members’ needs”.
