Smart Pension and L&G to develop first default retirement pathway

The default, to be created in collaboration by the two companies, will also include a ‘rainy day’ pot of liquid savings and an amount kept back for leaving an inheritance.

Political pressure behind default drawdown is now difficult to ignore. Last week the Resolution Foundation added to calls from the Work and Pensions Committee and the Royal Society of Arts for the creation of defaults, or auto-protection.

The collaboration between Smart Pension and L&G now looks set to yield the first of these auto-protection systems, with delivery expected in 2019 and subject to testing. The product will be available to customers of both providers.

If we don’t innovate to help people I think there is a risk that retirees could adopt suboptimal strategies

Laura Myers, LCP

Nest, the mastertrust set up by government to support auto-enrolment, published its own retirement blueprint in 2015, but has so far been prevented from entering the at-retirement market due to industry backlash.

In terms of structure, the two products will look similar. Smart Pension and L&G envisage a flexible income drawdown fund that provides a steady income until age 80, at which point a separate pot will be used to buy an annuity.

Further testing will determine whether this will be a regular annuity, a deferred annuity bought gradually in the years leading up to payment, or a synthetic annuity. Fees are also unknown, but the two companies said they were “very confident” this could be achieved within the current charge cap.

Annuities match step-down in spending

Current modelling suggests that pensioners will be paid a slightly lower level of income from their annuity than they receive from their drawdown pot.

But the two companies maintain that this is appropriate for a retirement that is increasingly split into two phases; younger, more active pensioners are able to spend more, while older pensioners find that health limits them to a less adventurous and more frugal life.

Annuities also insure against longevity risk, and ensure that pensioners do not have to grapple with tough investment choices during a period of cognitive decline.

“Your lifestyle does change in later years,” said Emma Douglas, head of DC solutions at Legal & General Investment Management and a non-executive director of Smart Pension. “For that later life there is probably a place for considering some form of annuity.”

The product’s drawdown pot is expected to be exhausted by age 80, according to Smart Pension's director of business development Paul Budgen.

To give pensioners the confidence to spend their annual income, the product will also feature a ‘rainy day’ pot, to be used for any unusual expenses.

Finally, for those pots big enough to have leftover cash, the product can also earmark funds for inheritance gifts. Members will have the flexibility to choose how much they put in each pot, and whether they want to use all of the options.

Will pots be big enough?

Indeed, many current defined contribution retirees may find it hard to justify such a complex product, given the size of their pots. Andy Cheseldine, a client director at Capital Cranfield and chair of the Smart Pension trustees, pointed out that in the next few years, cash will continue to be the only option for many members.

He said the trustees will have to sign off any new product offering, but agreed that this could be a useful tool for the mastertrust’s population in the future.

“It’s worth us spending time and effort on thinking about the right answer for people and meeting those requirements,” he added.

Douglas said she hopes that pot size will be further swelled by consolidation, which may be encouraged by the launch of the pensions dashboard.

Laura Myers, partner and head of consultancy LCP’s DC team, agreed that now was the time to start planning.

“If we don’t innovate to help people I think there is a risk that retirees could adopt suboptimal strategies, for example by taking undue amounts of investment risk; by drawing out substantially more than would be considered sustainable; or... adopting unduly cautious investment strategies or drawing out too little,” she said.

Support is crucial

When the product does reach the market, it will have a major hurdle to jump in convincing members to engage with it.

Unlike a default in the accumulation phase, retirement pathways require the active consent of the member; not doing so would raise conduct issues for providers, according to Douglas, while Budgen said members would have to give a retirement date and bank details as a minimum.

To achieve this engagement, the two providers will look to use member MOTs, and to leverage Smart Pension’s expertise in fintech innovation.

This is crucial, argued Mercer’s UK DC and financial wellness principal Stephen Budge. Poor guidance will mean that savers do not even engage enough to “tick the box” on their retirement pathway.

“Unless you’re absolutely spot on with your messaging and engagement you’re still going to struggle,” he said. Technology can be helpful, but he said that the “individual touch” of guidance and advice may still be necessary to enable active decisions.