Thinktank the Centre for Policy Studies has highlighted the need to shield savers from financial risks in later life through the idea of “auto-protection”, with the introduction of auto-drawdown, followed by auto-annuitisation at age 80.
The proposals, which were made by the thinktank’s Michael Johnson, come after a 2010 CPS report argued the case for making most pension savings accessible at retirement. The pension freedoms proposal was later taken up by the government and came into force in 2015.
The state nudges and incentivises people to accumulate retirement savings, only to desert them at the start of decumulation
Michael Johnson, Centre for Policy Studies
Currently, private pension age is 55, but the paper dismisses this as “far too early”, suggesting it “should be swiftly raised to 60”. It argues that the aim of auto-protection is to reduce the exposure to financial risks in later life, including using up one’s pension pot too early.
Hedging longevity risks
Johnson, a research fellow of the CPS, calls for the introduction of auto-drawdown at private pension age, in the form of an income drawdown default of between 4 per cent and 6 per cent of pot assets a year.
He also proposes “auto-annuitisation” of residual pots once savers reach age 80, to “facilitate the collective hedging of individuals’ exposure to the unquantifiable risks of longevity”.
The paper states that everybody should be able to opt out of one or both phases of auto-protection “to pursue alternatives”. It adds that the auto-protection “would address a major policy inconsistency, whereby the state nudges and incentivises people to accumulate retirement savings, only to desert them at the start of decumulation”.
An initial income drawdown default would significantly reduce the “risk of ruin” and “exposure to pot conversion fraud”, states the paper.
Johnson stressed that the most fundamental issue, however, is that people are not saving enough.
“Unless working-life savings contributions are substantially increased… then many people are likely to run out of money before dying, irrespective of the design of any retirement default,” the report reads.
Nigel Peaple, deputy director defined contribution, lifetime savings and research at the Pensions and Lifetime Savings Association, said the paper raises a number of important questions.
These are, for example, "how can people be nudged and guided to choosing a sensible drawdown product when research suggests they want an annuity; and how can the over-80s be nudged and guided into buying an annuity so soon after the government removed the requirement to do so", said Peaple.
Guidance is there, but people need to use it
But Martin Tilley, director of technical services at Sipp provider Dentons Pension Management, disputed that the state ignores those at retirement.
He said that “to say they’ve been abandoned” was not true given the guidance available to savers, such as Pension Wise, the Pensions Advisory Service and the government incentive of a £1,500 allowance charge facility to put towards financial advice.
“The opportunity is out there for individuals to obtain either well-constructed guidance, or advice, if they can just be persuaded to go and look for it; and I think that’s the issue… individuals need to be encouraged to go and obtain that guidance,” he said.
Andrew Pennie, head of pathways at advisory Intelligent Pensions, disagreed: “I think people do need more protection from the risks in drawdown... too many people are going into drawdown without understanding the risks.”
Pennie added: “We’re seeing people not taking up guaranteed annuity rates, we’re seeing people getting caught by scams, so we can see that there are a lot of potential mistakes going on which could cause people to either lose out financially or run out of money.”
Too prescriptive
He said it would therefore be a positive thing if the industry were to establish something that raises awareness and protects these people, said Pennie.
Why we need a minimum income for drawdown
Comment: The OECD recently identified the increasingly important role of defined contribution arrangements in providing retirement benefits as one of the international pension trends.
However, he argued that the way in which the Centre for Policy Studies paper proposes to tackle these issues “is just too black and white” and “prescriptive”.
Overall, “it just needs to be more personalised” and finding a sustainable withdrawal rate will vary for each individual, he said.
Tim Middleton, technical consultant at the Pensions Management Institute, noted that the idea of having annuitisation once people reach an older age – as a safety net in case they run out of money and live longer than they thought – has been proposed before. Nevertheless, he said, “it is a good, pragmatic idea”.
However, Middleton said the model would work better if people were to buy deferred annuities at the point of decumulation as this would better deal with mortality drag.
Mortality drag refers to the extra investment return required to overcome the effect of life expectancy increasing as individuals get older, and the cost this creates if people delay buying an annuity.
Middleton said earlier annuitisation “would be a lot less expensive than requiring people to buy default lifetime annuities at the age of 80".
