The pros and cons of offering drawdown to your members

All schemes must offer flexibility to their members and trustees will have a key decision to take in relation to how much of a role they want to play in facilitating this.

Some will prefer just to cash in their chips at retirement and the ongoing demands and investment decisions required of drawdown will prove too much

Traditional annuities will remain an option for retiring members and they could be the preferred option for individuals who prefer simplicity and certainty of income in retirement, or for those qualifying for enhanced terms.

For many, the inflexibility and the perception of poor value, especially for those who underestimate their longevity, will make them unattractive. For the confident retiree, drawdown presents the attraction of controlling the level and frequency of income to suit their needs.

It offers the potential for future growth with the option to buy an annuity later if preferred. Following more recent announcements, it will even be possible to pass on any residual pension pot to a beneficiary in a tax-efficient way.

For some individuals, drawdown will not be appropriate. Some will prefer just to cash in their chips at retirement and the ongoing demands and investment decisions required of drawdown will prove too much.

The very real risk of running out of money or needing to restrict income will swing the pendulum in favour of annuities for these investors.

In other countries where pension flexibility is well established, evidence shows that the majority of savers will take their retirement income to suit their circumstances and that only a minority will purchase an annuity.

The mechanics

Assuming the UK follows suit, trustees will need to consider or reconsider how drawdown operates in their DC schemes.

Should members be pointed toward the open market or should trustees administer drawdown through their own scheme?

Under current restrictions, only a small proportion of members have been able to access drawdown. For simplicity, most trustees have directed members to retail products available in the open market, sometimes connected to an existing provider.

One outcome has been that the big insurers now have a headstart on the market, having refined their drawdown capabilities over a period of time.

With a significant increase expected in the proportion of members choosing drawdown from April next year, trustees will need to consider their appetite for taking a more hands-on role in its administration. There are some important issues to consider:

Ongoing involvement and governance. The administration of drawdown is a potentially large step for trustees who may be used to discharging all responsibility for their DC members when they retire.

It represents a significant extension of the time period over which there is a governance responsibility toward members, which in turn introduces risks. For trustees with existing defined benefit sections, the step may appear less daunting, but the governance of drawdown will still be rather different to the governance required toward DB pensioners.

Communication and tools. The need for clear communication and modelling tools will be greater than ever in order to give members the information they will need to manage their own funds.

Drawdown requires members to be actively engaged throughout retirement. As members get older, the decisions remain just as complex, but models and communication styles may need to be refined and simplified to acknowledge this.

Capability and capacity. The administration of drawdown is likely to attract greater scrutiny from the Pensions Regulator and other stakeholders, particularly while the new regime beds in. Some providers will be better equipped than others to carry out this role from day one, and so due diligence is needed.

Assets under management and charges. One key attraction to trustees of retaining the responsibility for drawdown is retaining the assets underlying members’ funds. Depending on scale, this extra leverage with providers could lead to lower charges and, ultimately, better member outcomes.

For many trustees, the governance burden of administering drawdown will outweigh the potential benefit of lower charges – particularly for small and medium-sized schemes. In these circumstances, trustees may choose a preferred provider for their drawdown needs and seek economies of scale as far as possible.

Success will be defined by the handover from the pre-retirement phase into the drawdown phase which, in turn, will require smart communication and interaction with the government’s new guidance guarantee.

The market’s drawdown capability will increase, governance solutions will come to market and trustees will be clearer on the choices being made by scheme members.

Only then can we expect anything other than a small minority of trustees, who have access to the support required, to take a significant role in drawdown.

Jan Burke is head of defined contribution consulting at Aon Hewitt