The Pensions Management Institute’s Tim Middleton argues in favour of reintroducing a minimum income requirement for flexi-access drawdown.
In response to this trend, the OECD has developed a Roadmap for the Good Design of DC Pension Plans. Two of the contained recommendations promote annuitisation as the most appropriate form of decumulation.
Neither flexi-access drawdown nor UFPLS address the problem of longevity risk. This might turn out not to be a significant problem; alternatively, it could be a major scandal by the 2030s
From a UK perspective, this is striking. Here, for at least a decade, the tide has been turning away from annuities and towards the growing range of alternatives.
The term ‘annuity’ is tainted in the UK
Critics of annuities point to poor rates caused by low interest rates and improving longevity.
Press coverage of annuities has been almost universally negative, which has resulted in public antipathy towards a financial product that is condemned as offering poor value for money and no flexibility.
And although research has shown that the public remains attracted to the idea of a financial product that provides a guaranteed lifetime income, the term ‘annuity’ has become so tainted that some providers avoid using it when promoting their offerings.
Government policy has also actively sought to undermine annuitisation with the freedom and choice reforms; more recently there was an aborted attempt to introduce a secondary annuity market.
Is the OECD right to oppose this trend?
We should remember that the UK DC market remains relatively immature. According to the Pensions Policy Institute, in 2010, the average size of a DC fund on annuitisation was £25,874.
This is not necessarily problematic: the generation reaching retirement age now is likely to have legacy defined benefit pensions to provide the bulk of retirement funding.
However, the launch of auto-enrolment in 2012 has developed a cohort of mostly younger employees for whom a lifetime’s pension accrual will be exclusively through DC arrangements.
It is likely therefore that it will take a couple of decades before properly representative trends emerge concerning retirement outcomes that are principally reliant on DC pension schemes.
It is also difficult to see how the freedom and choice regime is likely to influence retirement choices.
To date, members have not – as some suggested – squandered their retirement savings on expensive Italian sports cars, although, in fairness, this would not have been an option with a fund of less than £30,000 anyway.
Lack of constraints within decumulation poses a risk
However, the absence of formal constraints within the current decumulation regime contains serious risks that cannot be ignored.
The decumulation market in the wake of freedom and choice
The post-retirement market is still catching up with the biggest pensions overhaul in recent history, as industry experts say more pensioners are leaning towards different drawdown solutions instead of annuitisation.
Annuity v drawdown: Dispelling myths
From the blog: The lead-up to the launch of the pension reforms in April 2015 created pent-up demand in the market, resulting in many opting to take advantage of the new freedoms and draw down a lump sum.
As long-term retirement strategies, neither flexi-access drawdown nor uncrystallised funds pension lump sums address the problem of longevity risk. This might turn out not to be a significant problem; alternatively, it could be a major scandal by the 2030s.
Perhaps the most prudent response would be the return of the minimum income requirement. This could take the form of requiring those accessing funds via drawdown or UFPLS to purchase a deferred annuity that would commence payment perhaps 20 years in the future.
A deferred annuity would avoid the problem of mortality drag and would not be a very expensive purchase.
The OECD’s concerns are valid, and perhaps our government should consider reforms before bitter experience forces their hand.
Tim Middleton is technical consultant at the Pensions Management Institute
