Pearson follows pack in targeting drawdown for DC defaults

Staff and former employees of the publishing company will see their pots derisked towards a goal of using drawdown products in the majority of cases.

While market studies still reveal a predilection for cash among current retirees, waning interest in annuities has seen a raft of schemes and providers switch to drawdown as their default target. Scottish Widows, for example, changed its clients’ derisking paths in August last year.

Pearson has similarly anticipated that a specialist income drawdown vehicle, outside of the scheme, will be the best option for members. After a review of its offering it decided to adapt its strategy to the pension freedoms era.

It’s no longer appropriate for schemes to assume annuitisation, and it’s also far more risky for them to assume that decumulation is associated with the end of somebody’s working life

Tim Middleton, Pensions Management Institute

“With the greater flexibilities now available to members, the trustee wanted to offer a range of high-quality options which are more aligned with the choices that are available at retirement and provide members with more flexibility to meet their individual needs,” said Pearson’s pensions director Stephen Beaven.

Members more than five years from retirement will be defaulted into the drawdown strategy.

Those who are closer to retirement with pots between £1 and £30,000 will derisk into a strategy targeting cash withdrawal, while those with pots larger than £30,000 and already near retirement will be derisked towards annuity purchase.

In all three scenarios, member pots are invested in UK, overseas and emerging market equities until 15 years before their selected retirement age. At that point, investments transition towards diversified growth funds, UK index-linked gilts and corporate bonds, with a portion remaining in equities.

At five years from selected retirement age the strategies diverge, with those targeting drawdown invested in a broad mix of higher and lower-risk funds.

“This is to try and achieve a balance of growth versus security on the value of their pension pot,” said Beaven.

A logical decision

Before the introduction of freedom and choice, 90 per cent of pots were used to buy annuities. Although the Financial Conduct Authority’s retirement outcomes review found that the majority of pots have been fully withdrawn since the reforms, drawdown is now twice as popular as annuity purchase.

“It’s no longer appropriate for schemes to assume annuitisation, and it’s also far more risky for them to assume that decumulation is also associated with the end of somebody’s working life,” said Tim Middleton, technical consultant at the Pensions Management Institute.

This trend has been reflected in a slew of schemes making similar changes to Pearson's.

“Everyone’s doing it,” said Paul Leandro, head of the north and Scotland team in Barnett Waddingham’s DC consulting practice.

However, not everyone is sold on the assumption that drawdown is a natural choice. Jonathan Watts-Lay, director at financial education and advice company Wealth at Work, called the use of defaults a “lazy” substitute for engagement.

Defaulting towards annuities could see a member miss out on important returns while locked into low-yielding bonds. Meanwhile, defaulting towards drawdown could leave them exposed to stock market crashes when they come to buy a pension.

“For accumulation the risk of [default options] is kind of low,” he said. “When you get to decumulation, the risk is massive.”

Educate, communicate, engage

Importantly, Pearson’s change has been communicated clearly in a letter to members, and support will be made available to encourage active choices.

“As members get closer to retirement we anticipate that members will be more engaged and so may switch to a different option depending on their individual needs,” said Beaven.

“To help drive engagement, the trustee is looking to provide members with financial education to support members [in their retirement planning].”

This support is essential because, as the FCA’s retirement outcomes review attests to, consumers are not shopping around for drawdown products and might be making poor choices.

“People are automatically going into the provider’s incumbent drawdown product without considering whether it’s the most appropriate drawdown product for them,” said Leandro.

The Work and Pensions Committee has called on the government to require providers to develop suitable “default pathways”, which would enable schemes and employers to carry out some of this due diligence.

However, until product innovation responds to these calls, Leandro recommended a retirement framework “focusing on engagement and education in the run-up to retirement”, followed by a “gateway service” where members can be pointed in the right direction, usually to financial advisers or guidance services.