UK could profit from Australia’s missed default opportunity

In response to a consultation on the future of retirement down under, which closed last year, consultancy Aon’s Australian branch had submitted proposals for a combination of longevity insurance, an income drawdown strategy set by trustees, and a flexible cash top-up.

The proposals were dropped by the country’s treasury owing to complications with tax rules, but Aon partners have now claimed the system could work well in the UK.

What they definitely don’t want is to make a big decision about their retirement savings... knowing that they’ll probably get it wrong

Kevin Wesbroom, Aon

The use of default pathways at retirement is gaining traction, at least in the trust-based sphere. Mastertrust Nest and thinktank the Centre for Policy Studies have both proposed similar blueprints.

The idea was floated by the Financial Conduct Authority as a remedy for poor retirement choices, and the influential Work and Pensions Committee has called on government to require all drawdown providers to establish a default option.

The case for a default

Of course, creating default retirement pathways is “certainly not the most pressing issue in [defined contribution]”, admitted Aon senior partner Kevin Wesbroom.

With auto-enrolment only in its infancy, pots belonging to those lower and middle earners who might struggle to afford financial advice are still too small even to merit a default drawdown service. Fifty-three per cent of pots accessed since pension freedoms have been fully withdrawn, according to the FCA.

Nonetheless, increasing longevity and evolving patterns of work and retirement demand fresh thinking. Annuities, while shown to offer improved yields if purchased between the ages of 75 and 85, have proved unattractive to consumers.

Non-advised drawdown customers are susceptible to so-called sequencing risk – with withdrawals started during a bear market leading to lower overall income – and tend to underestimate their longevity.

Unpacking the proposal

All this leads to confusion, and the industry suffers from “this misunderstanding that people want flexibility”, according to Wesbroom.

“What they definitely don’t want is to make a big decision about their retirement savings... knowing that they’ll probably get it wrong,” he said.

The details of the Aon proposal share similarities to previous proposals. A regular income would be paid out at a level set by trustees, alongside a flexible cash account for paying off debts, funding holidays or elderly care.

New research means the rate paid out each year should probably be lower than is usually claimed to be sustainable, Aon said, between 3 and 3.5 per cent a year.

At 85, the residual pot would begin to be paid out as an annuity, or more controversially, as a collective DC product. This would eliminate the possibility that savers run out of money.

Defaults are a risk for trustees

Much of the debate around the use of defaults in retirement hinges on whether advice is readily available.

“In the absence of either access or propensity to take advice, then it is a somewhat ineluctable conclusion that one has to provide some kind of default for those individuals,” said William Allport, senior retirement strategist for Vanguard in the UK.

“One of the problems when you think about defaults is there’s a significant degree of risk to the decision-makers,” he added, pointing out that trustees could come under fire.

He agreed that good retirement products are likely to need to be structured to cater for people’s essential needs, discretionary spending and more unusual spending like bequeathments, but pointed out that insurance products like annuities could be replaced by bond ladders or other asset management products.

Advice could be made accessible

Meanwhile, some commentators doubt the commercial appeal of drawdown with guarantees, for all its apparent merits.

“That probably gets closest to where you would want to be, but it’s very complex and it does come at a cost,” said Steven Cameron, pensions director at provider Aegon.

Aegon had offered a similar product, albeit with much greater flexibility, to the advised market, but it failed to win favour with advisers.

“We’ve always felt that the holy grail is to get everyone engaged with pensions, and defaults should only have any role if you’ve failed to get everyone engaged,” he said.

With the possibility that defaults discourage engagement and end up being sub-optimal for the needs of a diverse population, Cameron said he preferred to “look creatively at how we can plug the advice gap”.