Guidance needs stronger nudges to prevent future disaster

Every day we are assailed by a raft of gentle pressures that steer our choices, from fruit that is put at eye level, to even stronger nudges such as HM Revenue & Customs sending letters encouraging people to pay their tax debts.

Nudges are working with staggering success in pensions, where more than 10m UK workers have been automatically enrolled into a workplace retirement plan by their employer since 2012.

There is a very high chance that without this robust nudge most people would not have taken the step of signing themselves into their own workplace pension. 

The fact that most people are accessing their pension pots, without taking formal advice or impartial guidance first, is a red flag that suggests trouble is storing up for the future

Nudge theory — or the science behind subtly leading people into the ‘right’ decision — was invented in this country and has gone on to become a key part of the regulatory toolkit for watchdogs, including the Financial Conduct Authority.

Given how embedded behavioural nudges have become in our lives, it is legitimate to question the strength of the nudges used to manipulate us towards better decisions.

This is a question that is very pertinent to consumer issues bubbling away in the retirement income market, triggered by the 2015 pension freedom reforms, which gave over-55s full freedom and choice to spend their retirement cash as they wish.

Half of pension pots emptied at first go

There are growing signs that many people are not making wise choices when it comes to exercising their pension freedoms.

According to FCA data released in September, around 670,000 defined contribution pension pots were accessed for the first time in the year to March 2020, a record high since the start of the pension freedoms.

More than half of those plans (375,000) were emptied at first go, with fewer than one in 10 over-55s using their savings to buy an annuity, which delivers a secure retirement income for life.

Most people are plumping their savings into riskier stock market-based drawdown accounts, where there was evidence that nearly half of those making regular withdrawals (42 per cent) were doing so at an unsustainable rate of more than 8 per cent a year.

We cannot say for sure if the people who emptied their pension pots, or who are withdrawing large amounts of cash, are making poor decisions.

But the fact that most people are accessing their pension pots, without taking formal advice or impartial guidance first, is a red flag that suggests trouble is storing up for the future.

Avoiding the ‘pension traps’

As most people who work in this industry will attest, pensions are full of traps for the unwary. These traps can include overpaying tax on withdrawals, to being stung by high charges on drawdown plans, to not understanding the inheritance tax protections of pensions. These traps exist even before we get to a discussion about how to make a pension pot last.

Recognising these potential pitfalls, the government in 2015 set up the Pension Wise service, which today offers over-50s around the country free and impartial guidance on their options for DC pots.

By all accounts the service is highly rated by those who attend a free 45 minute face-to-face or telephone appointment. Nine in 10 customers (93 per cent) who used Pension Wise felt very or fairly well informed of their pension options after an appointment, per the Money and Pensions Service.

Despite evidence Pension Wise is influencing better outcomes, fewer than one in four who accessed their pensions in the year to March 2020 (160,000) took advantage of a free Pension Wise appointment.

The FCA is currently considering ways to boost Pension Wise take-up, having acknowledged the huge risks the pension freedoms have placed on retirement income adequacy.

Robust nudges needed

One option thought to be favoured by the FCA would see stronger nudges to Pension Wise.  

Currently, pension companies are only required to signpost customers towards Pension Wise in written pre-retirement materials, or when they call to ask about accessing or transferring their pensions. But this has proven a little limp in getting people through the Pension Wise door.  

The FCA is thought to be eyeing a stronger nudge that would see pension companies either offering to make a Pension Wise appointment for a customer or transferring them to a member of the Pension Wise booking team. 

The regulator may be attracted to this intervention, given it is a polite shove towards better outcomes without being too intrusive. 

However, recent trials showed the intervention only led to a very modest improvement in appointment take-up.  

A more robust nudge, such as defaulting people into a Pension Wise appointment, with the choice to opt out, could be the transformational change that is needed to improve retirement outcomes and the regulator could do well to consider it.

Josephine Cumbo is global pensions correspondent for the Financial Times