Pensions freedom and choice will celebrate its second anniversary in the spring. Helen Swire looks at whether savers are making the right decisions
As we start the New Year, is the end already in sight for you? Is 2017 the year you plan to retire? Looking forward to putting your feet up – and even more so now your pension money is yours to spend as you choose?
People approaching retirement are likely to be anticipating a simple approach to living off a comfortable annual income.
Certainly, automatic enrolment is having a positive impact on savings. The Institute for Fiscal Studies released figures in November that showed 88% of eligible private sector employees were members of
a workplace scheme, while pension saving has increased by £2.5bn.
But the savings news isn’t all good. Financial stress is still significant, with 64% of Generation Y workers reporting concerns about their finances (Willis Towers Watson’s Global Benefits Attitudes Survey 2015/16).
Meanwhile, Aon’s Defined Contribution Member Survey 2016 showed that four out of five pension scheme members are not saving enough, with only 16% contributing enough to be able to maintain their standard of living in retirement.
So over the past two years, have people been making the right choices with their retirement income to have that good standard of living? And if not, why not?
“Employees have gone from an annuity path to five choices,” says Steve Charlton, DC (defined contribution) proposition manager, Europe, at Vanguard. “They could take cash, draw down, buy an annuity, do nothing, or do a mixture of all these.”
Charlton suggests that there is almost too much choice. He says: “Auto-enrolment effectively came about because the government didn’t trust people to join pensions, either out of apathy or mistrust. But while they don’t trust you in accumulation, when it comes to decumulation – and the most important decisions you’ve ever made – they’re going to give you carte blanche, with a huge number of choices.”
So far, the choice has been so overwhelming that for many people the answer has been to do nothing. Figures emerging from the Pensions Regulator are showing a drop in annuity purchases and that some people are taking small cash pots, but there has been no huge swing in the direction of one specific choice.
Considering that many current retirees still have defined benefit pensions to rely on, it is early days to pick out particular trends in the defined contribution sphere: those will start to develop as the sole-DC employees reach retirement.
One fundamental issue, however, is the lack of understanding around what choices are available – and what they mean in practice. Staying in the default fund, for example, is not necessarily the most effective decision, but taking cash and investing it is often an inefficient solution.
“The industry has collectively made this leap of faith that people are going to work out what to do,” says Simon Chinnery, head of DC client solutions, Legal & General Investment Management (LGIM).
“But people don’t really know what they want to do. For example, if they put their money into the wrong de-risking strategy, combined with having to then work longer, it’s a recipe for disaster. People want guidance, they want advice, and they want to know they’re doing the right thing.”
For Chinnery, there is a clear problem with complexity, down to the level of terminology. If members don’t even understand the jargon, what hope do they have of making the right decisions?
Compounding this is the fact that the conversation around pensions flexibility ends to be something that is discussed with members on the cusp of retirement – when it is generally too late to do anything if they haven’t saved enough.
Ian McKenna, director of the Finance & Technology Research Centre, warns that pension freedom and retirement choices need a long-term view.
“We really need to educate savers over their working life. There may be no need or someone of 35 or 45 to understand the ins and outs of all the options: what’s really important is how we take the customer on that journey, to enable them to gain knowledge and confidence,” he says.
“Do they feel comfortable with taking major financial decisions, and do they feel in control? If we can help them be in control, they’re in a better position to save.”
It’s true that the major barrier to good decision making may start considerably earlier than retirement. If people’s financial lives – from debt management to an adequate understanding of savings – are not in good order, how can they take confident, practical and, most importantly, correct decisions?
Of course, employees need input from their employer: whether that is a matter of simply choosing appropriate schemes and providers or whether it extends to a greater involvement in financial education.
The more active and paternalistic employers are adjusting to a more supportive role, says to Paul Waters, head of guided outcomes at Hymans Robertson.
“With the shift from DB to DC, and now people can take their pot flexibly before retirement, it’s become much more of an internal HR issue,” he says. “Employers are having to learn about freedom and choice at the same time as their staff, with the added new dynamic of looking at communications and making sure people are saving enough.”
The employer-learning process is crucial in ensuring that the right schemes and investments are chosen for the workforce.
Before making any fund decisions, they need to understand their employees: their different cohorts, the savings they have, how many people are approaching or are at the point of retirement and so on.
“If employers are starting to see more people thinking about retirement, they will need to think about what they’ve accumulated over their working lifetime and where, for example DB and DC, and therefore what choices they will want,” suggests Charlton.
“Will they want a cash option? Will they need more advisory guidance? Do you give them the opportunity to consolidate past DC savings into one big pot? It’s that type of thing that employers will have to start thinking about. And that means they’ll have to have a much better idea of what their working demographic is like.”
And when making that decision about which funds to offer, do employers know the difference between the options and understand which structures support the member experience they want for their workforce?
Chinnery says that a partnership between employers and providers supports a better decision-making process.
He says: “Providers are at the front of where people expect help to come from. They have that investment knowledge that enables them to understand the wider risks – market risks, longevity, efficient utilisation of money and so on. And they can also engage with the employer to help them grow through what’s coming up in the next few years.”
Thankfully for businesses, pensions technology is also rapidly coming up to speed in order to help them.
“We see technology as the best way for employers to address these issues,” argues Hymans Robertson’s Waters. “The range of circumstances in the workforce, the size of their pension funds and the complexities mean that members need personalised, contextualised information. With technology you can communicate individually with people and point them to the right support.”
The long and winding road
There is still a long way to go in ensuring that people are making the right decisions at retirement: and that is before any major political shifts come into play (nobody mention Brexit).
The proposed pensions dashboard, due in 2019, will be a step in the right direction in helping members understand their savings pots and what their annual income expectations in retirement will be.
While this signifies important progress for the industry, it does not solve on its own two key issues.
Firstly, engaging with saving in the first place. Waters says: “Employers need to be addressing the under-saving issue now, looking at how they’re communicating with people with different requirements.”
The second question is around making sure employees understand their choices – and the implications and pitfalls of what they do.
But, as LGIM’s Chinnery points out, it would be a big mistake to extrapolate future trends from today’s picture.
“What is happening now shouldn’t shape the future: in ten years’ time it will be about the most efficient design that will suit the most people,” he says. “We can’t end up second guessing defaulters and putting them all into different streams of retirement options: we have to look at diversified portfolios.
“They can then look at their choices – and the default option – with the appropriate education and advice from their employers.”