The DC Debate – how the freedoms are changing the direction of DC

What do early member reactions to the freedoms tell us about people’s attitudes to pension saving?

Barry Parr: Early reaction tends to be very positive about the benefits of flexibility and allowing personal choice – but of course that’s the reaction from some of those who have a pot of sufficient size to make the issue meaningful.

I have also heard a number making the observation that as they have next to nothing in their pots, it’s all a little academic. Nevertheless, the new possibilities must help sell the potential benefit of pension saving for a younger generation.

Alan Morahan: Early reactions are probably not going to be fully representative of what will happen. There will have been a pent-up demand, with a number of people waiting to access their benefits for a variety of reasons, from paying off debt to more frivolous spending – there will always be this element.

However, reports coming through from the providers are quite encouraging. Many people have been asking quite searching questions, indicating a desire to fully understand the implications.

Reports coming through from the providers are quite encouraging. Many people have been asking quite searching questions, indicating a desire to fully understand the implications

Alan Morahan, Punter Southall

Emma Douglas: It’s too early to see clear trends. Surveys show that pension freedoms are popular but the majority of early enquiries were about cash withdrawals. More complex decisions will take longer. Although last year’s Budget brought retirement decisions into the spotlight, people’s attitudes toward retirement had already been in flux. Many had already begun to extend their working life past their state retirement age.

This trend looks set to continue, and the new freedoms, alongside auto-enrolment, may support it, creating a sense of ownership of pension savings.

Andy Dickson: Providers have seen a three to four-times increase in customer enquiries. One provider was quoted as seeing 20 per cent of customers cashing in their pots in full, including one customer with a £1m pot. These withdrawals are being used for a variety of purposes, from repairing a local church roof to paying off debt. It therefore appears that the original purpose for pension savings to provide retirement income has potentially been broken.

Mike Spink: The reports we’ve seen do of course cover all DC pot holders rather than simply workplace pot holders. Within the latter population, many employers and trustees will have arranged for some form of member communication to be issued, whereas the balance of the DC population will largely have relied upon various media channels for their information.

Early days, but it appears our initial thoughts were correct. But we won’t know for a few months whether the relatively high number of initial enquiries will lead to a significant level of total ‘cash out’ for larger pot sizes. For relatively small pots, such action may of course be a rational decision.

Mark Futcher: With £196bn of personal unsecured debt and low interest rates, the ‘run to cash’ was predictable, but not atypical of how people will use their pension savings in the longer term. Freedom has undoubtedly changed how people view pension savings, and their relationship with their later-life savings will be much more akin to Isa savings.

Unfortunately, people do not appreciate the value of a guaranteed income, as they underestimate their life expectancy; this will create another mis-selling scandal unless we engage the members.

Alistair Byrne: I’m not sure the early reactions tell us very much at all about attitudes to saving and consumption into the future. People queueing up to get access to their savings are likely to have different preferences to the wider population, for example people with short-term financial difficulties or significant distrust in the pension system. While this covers a significant minority, we expect the wider population to take a more considered view and seek to retain their assets to provide income in retirement.

Steve Charlton: The headlines around pension freedoms seem to have been limited so far. This probably highlights the lack of engagement in pensions that many in the industry have seen for years.

In the short term, I expect interest to be around cashing in small pots or taking cash from annuities that provide very small amounts of income. This might suggest people view these small pots as a means to an end and that the end is not income.

To what extent does this inform the longer-term direction of DC from both employee and employer perspectives?

Parr: It’s still much too early to form any judgments in this respect other than to fully recognise the situation has changed significantly. Oddly, from the employer’s perspective, the bondage with the employee lessens as the latter more clearly takes control of his or her own life choices. In turn, this will encourage more employers to question why they even run their own branded pension scheme. The mastertrust or contract scheme – or ‘supers’ – shall flourish.

Morahan: Until April, pensions had a prime task, namely to provide income in retirement. The flexibilities open them up to being long-term savings plans which might be of more interest to employees. Employers have typically seen pensions as both a recruitment tool and as a way of enabling people to retire from the workplace. If the working population start viewing pensions as just a savings vehicle, employers’ support may start to wane, with compliance being the main driver for providing them.

Douglas: Most employees will face more complex retirement decisions than before. Many have little investment experience and may view the default fund as implicit advice. Providers will need to develop a new retirement product range aimed at a much wider audience, focusing on transparency, simplicity and low cost. Employers and trustees, with provider support, will need to focus even more keenly on governance, education and communication in order to support appropriate decisions.

Dickson: In the past, workplace pensions were viewed by both employers and employees as a form of deferred pay. Now, for many, workplace pensions are in essence a deferred cruise.

Providers will need to develop a new retirement product range aimed at a much wider audience, focusing on transparency, simplicity and low cost.

Emma Douglas, LGIM

Employers may take a view in future that the cost of providing more generous pension contributions than legislation requires is difficult to justify. The continued reduction in the lifetime allowance and proposals to reduce tax relief could increasingly disenfranchise many key staff as well as middle-income workers from pensions completely.

Spink: We can probably expect to see a demand for more innovative income drawdown arrangements.

We think a number of providers may have delayed investment in this area pending an understanding of actual, as opposed to perceived, behaviours. Seeing employees acting in a reasoned manner has to be positive: while the employer can no longer be sure their scheme will provide an income for the life of each former employee, they are much more likely to want to consider adopting contribution levels above auto-enrolment minima.

Futcher: What we have not seen yet is the innovation from investment managers and retirement income providers. There is a real necessity to have secure, stable income in retirement but with flexibility if circumstances change – obviously this flexibility will come at a price, but that is market driven.

Arguably, DC pensions died when the Budget freedoms were announced. It is just another glorified savings account.

Why will employers want to pay more than they legally have to under auto-enrolment if it is no longer a viable retirement, recruitment, retention and attraction tool?

Byrne: Employees will value the fact they can get access to their assets relatively early, even if in the end they don’t choose to do that. For employers, this is all part of accepting that the nature of what we used to call ‘retirement’ has fundamentally changed from a binary, predictable event to a gradual, unpredictable flexible phase. Employers will need to come to terms with how they might adapt their DC schemes while at the same time using them for strategic workforce-management purposes.

Charlton: I suspect that none of the initial activity will inform long-term behaviours. I think it will be several years before we actually see any meaningful trends in scheme members’ activity around retirement savings.

This isn’t very helpful for employers who are being encouraged to provide solutions to meet all potential outcomes. Although, in many ways, employers find themselves in the same situation that they have done many times before – they have to provide the best solution for many even if it doesn’t fit the needs of all.

How will the changes influence the design of DC schemes?

Parr: We can presume that the defaults will be changed in response how popular certain options become – and perhaps according to other factors such as pot size. We may well find that age also has an influence because the spending patterns post 55 may be very different to an individual who is making judgments at age 75. And with time we can also expect more depth to enter design considerations such as having varied risk-return profiles according to choice or life factors.

Morahan: Schemes and their defaults will need to take notice of the trends that will develop in the way members access their benefits. Until April, the pension access point for most people was a fixed retirement age. With the new flexibilities, people may access their pension pot on a number of occasions over a number of years – therefore investment volatility will be a bigger issue, which will need to be better managed.

Default strategies need to be robust to the uncertainty of when and how members will retire

Alistair Byrne, SSGA

Douglas: DC schemes and their defaults will need to address changes in retirement patterns as well as different investor needs, such as the need for continued asset growth in phased and post-retirement stages; the potential desire for a stable income for all or part of retirement; longevity risk; appetite for different types of savings and retirement solutions, leading to membership segmentation.

Dickson: It is not straightforward, as the pension savings journey for most people will go beyond membership of their workplace DC scheme to using drawdown in retirement. Analysis we have undertaken identifies that retaining investment risk, with controlled volatility to and through retirement, produces better outcomes for many DC savers.

Spink: It will be the member behaviours, rather than the freedoms themselves, that will influence what happens next. We expect most schemes to end up offering something of this nature:

• A ‘compromise default’ that acknowledges many members won’t know how they’ll want to access their pots until close to retirement. This central default will take a multi-asset approach with a high passive-management bias;

• A suite of three ‘targeted’ investment strategies, aimed at either annuitisation, cash-out or income drawdown. Such strategies would be highlighted to members each year from their late 40s onwards to promote engagement with the scheme and members’ retirement aspirations.

Futcher: It will no longer be a linear experience. People will take blocks and chunks of money as and when they wish. How members access their savings should determine the investment strategy, and employers and trustees will need to understand the cohorts of members. It may well be there are distinct groups that require a different investment strategy, or it could be that a catch-all investment solution is required from which it would not be a bad place to take cash, drawdown or an annuity.

Byrne: Default strategies need to be robust to the uncertainty of when and how members will retire. This means the investment strategy is not optimised for, say, purchasing an annuity or taking 100 per cent cash on the member’s 65th birthday, but rather delivering an appropriate overall level of risk that will allow the member to make retirement income choices as their plans become more defined. Broader scheme design needs to adapt to allow members a smooth path to the various means they might use to access their retirement assets.

Charlton: They will have a significant influence on DC schemes. The traditional lifestyle default will become increasingly cumbersome and difficult to adapt to changing behaviours. This in turn will lead sponsors to look at newer options, such as those that reduce the administrative burden and those that increase the ability of the scheme to meet members’ needs. After all, more choice does not always lead to better decisions. Schemes will need to put more work into design to ensure optimal outcomes for members.

Will a new government bring further changes? And might some of these look to rein in some of the new flex?

Parr: We will always see more change and perhaps adjustment to the new structures as issues are identified.

We could also see new options emerge with the possibility of collective DC – this could provide some interesting options especially in the decumulation field. We might expect some taxation opportunities to be too attractive to almost any government to ignore.

Morahan: Most changes go through with barely a whimper of protest. Therefore, I believe further changes are likely as pensions are viewed as an easy target by politicians.

There have been repeated calls for a period of stability from the pensions industry. Time will tell if we ever see this, but I am not betting on it

Andy Dickson, SLI

Some of the changes have been necessary, but things like the continuous tinkering with the lifetime allowance just add layers of complication and are unnecessary. The biggest threat to the flexibilities is scams, with the contagion effect these could have on the whole industry.

Douglas: There are several areas where further legislation may be needed, including pensions taxation, pot-follows-member and annuities reselling. However, significant restrictions on the new flexibilities are unlikely, given their popularity. Ros Altmann, the government’s older workers champion, recently advocated supporting those who want to work longer – the new freedoms could be an enabling factor for supporting this process.

Dickson: The Work and Pensions Committee has recommended that the age which people can access their pension savings is hiked to just five years prior to state pension age rather than the current 10 years. It therefore feels inevitable we will see further changes to pensions after the election. There have been repeated calls for a period of stability from the pensions industry. Time will tell if we ever see this, but I am not betting on it.

Spink: From the manifestos it’s clear further change is on the way. It seems likely the LTA will be reduced, the annual allowance might be reduced, tax relief for very high earners may be reduced – and this could extend to lower earners via a new ‘harmonised’ rate of relief at some point between basic and higher tax rates. In particular, we know a Labour-led administration would seek to introduce certain protections – perhaps in the form of a cooling-off period where the pot value is above £30,000. And while continued changes aren’t particularly welcome it’s difficult to argue pensions tax relief isn’t ripe for review.

Futcher: Stop tinkering! Long-term pension planning should not be subject to political noise and we have had radical changes over the past 10 years. I think if we do see any changes then it would be a minimum income floor, like we had prior to April 6 – £12,000 a year would seem to be a sensible figure and is often quoted as the minimum annual income needed. Over and above this, people can enjoy the freedoms, this will in turn encourage pension saving.

Byrne: A drawdown charge cap, consistent with the accumulation phase, might be seen to be warranted if the market does not appear to be delivering value for money. However, we are optimistic the regulatory and governance arrangements in place now should be able to deliver good outcomes. It would seem difficult for government to rescind the reforms without significant evidence it is creating poor results.

Charlton: I think we need some time to work through the complex legislation that allowed for the flexibilities. But it’s inevitable that any new government will tinker either with the recent changes or in other areas.

It would be nice to think this tinkering would focus on letting the changes settle and on ways of engaging with the next generation of retirees to help them understand what they need to save to achieve an adequate income when they stop work.