Pensioners could lose out through new guided retirement models if they involve active choices at any stage, researchers at the Behavioural Insights Team have warned.
Defined contribution (DC) providers are exploring default options for their members at retirement to ensure savers can receive an income by default when they reach retirement age.
However, research by the Behavioural Insights Team commissioned by the Institute and Faculty of Actuaries (IFoA) has found that proposed models that are based on active decisions by members risk exposing them to financial losses due to drawing down too much or too little from their pension pots.
The Behavioural Insights Team’s research assessed four proposed models for default retirement options and tested them against consumer behaviour in relation to retirement decision-making.
The researchers cited a finding from the Pensions Commission that three quarters of DC savers over the age of 40 had no plan for how to access their pension at retirement, which they said meant “millions of pensioners could end up with reduced savings without action”.
The Behavioural Insight Team said that “any design requiring active decision-making in later life is at serious risk of failure as inertia and cognitive decline take hold”.
This in turn meant that ‘flex then fix’ approaches would likely be most suitable as default retirement options, as long as the ‘fix’ element was automated or had a default route. The report indicated that the inertia-driven success of auto-enrolment should also be used to guide the development of default retirement solutions.
Sujatha Krishnan-Barman, head of consumer markets and online safety at the Behavioural Insights Team, said: “Guided retirement solutions are an important development, rightly aimed at bolstering the protections for pensioners who have to make complex choices around their pension pots, while ensuring they will be able to access their savings throughout their retirement.
“But if designs for retirement options don’t take into account the factors that affect decision-making in retirement, including cognitive decline, this new regime could lead to millions of pensioners suffering from financial losses. Defaults only work if they’re built around how people actually behave, not how we’d like them to. That’s the only way the path of least resistance reliably leads to a secure income.”
“A decade of pension freedoms has shown what can happen when individuals face complexity without guidance or guardrails, and the results can be devastating.”
Paul Sweeting, president of the IFoA, added: “A generation ago, the Pensions Commission set the template for how reform is done well: assemble evidence, build consensus, and design a system that works with human nature rather than against it. Automatic enrolment transformed retirement saving not by turning millions of people into financial experts, but by making the path of least resistance a good one.
“Guided retirement is this generation’s equivalent challenge, but it is harder. A decade of pension freedoms has shown what can happen when individuals face complexity without guidance or guardrails, and the results can be devastating.”
The report also highlighted a “dilemma” for trustees responsible for implementing default retirement strategies. While flexible approaches may avoid putting members into irreversible positions, the Behavioural Insights Team said such approaches required “continuous management” by members who may not engage with their pensions.
Instead, they urged regulators to “establish clear legal safe harbours” for trustees and providers when implementing defaults, so they can be confident that if savers do nothing, they will still end up with “a defensible outcome”.
International evidence for ‘flex then fix’
Separate research from US financial services giant TIAA and its asset management arm Nuveen also indicated that a ‘flex then fix’ model offered a strong option for UK pension schemes and providers.
TIAA’s research arm, the TIAA Institute, assessed a range of approaches from different countries. It found that incorporating guaranteed income in later life with the ability for members to opt out has led to positive outcomes in countries such as Switzerland and Chile, with large numbers of people receiving annuity-like income streams.
The research also found that most members chose to lock in a guaranteed income within a year of starting to receive their pension.
Harriet Steel, global head of institutional distribution at Nuveen, said: “For pension schemes and providers, there is an opportunity to draw on this international evidence now, to refine product design and default architecture as proposals take shape.
“For policymakers, the message is one of confidence, with the evidence suggesting that patience, consolidated pots and clear messaging will allow the UK to build something genuinely world-class.”
Sophie Ballard, Nuveen’s head of UK institutional distribution, added: “The evidence is broadly encouraging, showing that integration rather than mandation can achieve meaningful rates of guaranteed income adoption, aligning well with the UK’s guided retirement approach.
“But our research also shows that meaningful change takes time. As an industry, we must recognise this and allow schemes and providers the space to adapt, embed new approaches and become accustomed to new initiatives.”
