Freedom and choice one year on – how far are we now?

The stampede has eased, but the Financial Conduct Authority's retirement income market data bulletin of April 2016 shows the full range of choices being made. Member behaviour has been reasonably consistent since April 2015, with smaller pots being fully cashed in and drawdown outstripping annuity purchase by more than two to one.

The proposed Lisa design will be a potential way of building up substantial assets for retirement, but the same challenge of converting capital into a sustainable income will remain

So freedom and choice has been a literal success, but are we moving further away from the concept of pensions as a means of providing replacement income in retirement? There is little or no evidence of members making rash decisions or unwittingly triggering excessive tax liabilities. However, there are indications that members may be struggling to make the most of their new-found freedom.

Still too little shopping around

The FCA data show that nearly two-thirds of annuity purchases have been from the pension provider, a worrying echo from before last April when concern over members not accessing open market annuity options was one of the drivers for the reforms. Similarly, about 50 per cent of drawdown purchases have been from the pension provider. The slightly improved rate of shopping around is likely to be due to opportunity, with many schemes still not offering drawdown as a retirement option from the scheme.

Making appropriate retirement decisions can have a huge impact on the value members get from their DC pension and choosing a competitive annuity or drawdown contract is an important part of that. On the face of it less than half of members are doing this.

The challenge of predicting future longevity and economic returns makes generating a sustainable lifetime income difficult – as trustees and sponsors of defined benefit schemes will attest to. It is even more difficult on an individual basis and when viewed against this objective, there are also potential warning signs.

The majority of retirement actions have been full encashment, predominantly smaller pots which would not have generated material retirement income. 

Investing for the long term

Those in drawdown will often have some exposure to equities for long-term real growth. The class of 2015 would have seen the FTSE 100 break 7,000 and reach all-time highs in the first few weeks of the freedoms, only to fall below 6,000 before Christmas. Investment losses early in retirement impact particularly hard on drawdown.

The rate of income being taken in drawdown varies widely, with the FCA data showing 41 per cent made a quarterly withdrawal of less than 1 per cent, but with nearly one in five making quarterly withdrawals between 2 per cent and 4 per cent. This represents a very wide range of behaviour, from the (over) conservative to the unsustainable.

The current generation of DC retirees include those who have also benefitted from DB pensions and decades of buoyant property markets. Their DC funds will therefore often not be their only source of retirement wealth, so full encashment, investment losses or not shopping around may not be a threat to having adequate retirement income. This will not always be the case for future generations.

The 2016 Budget protected the pension tax regime and introduced the Lifetime ISA, which will be tempting for eligible individuals and some employers. We expect it to attract a growing proportion of future savings that would otherwise have been put into DC pension schemes.

The proposed Lisa design will be a potential way of building up substantial assets for retirement, but the same challenge of converting capital into a sustainable income will remain. Indeed it will be even more of a challenge as it combines retirement saving with wider financial objectives. Furthermore, tax-free withdrawals after age 60 mean that there will be no taxation incentive to stagger withdrawals over retirement.

The direction of travel is towards a more holistic approach to saving. However, more freedom and choice means more difficult decisions for members. Equipping members to make good choices will be vital in achieving good outcomes and we believe this is one area that employers, trustees and providers will need to focus on even more in order to ensure everyone gets good value from the evolving pensions and savings landscape.

Mark Pemberthy is director at JLT Employee Benefits