The transition from a defined benefit (DB) to defined contribution (DC) model means workplace pension savers transitioning into retirement face a confusing, risky and uncertain future. The market volatility of the Truss/Kwarteng era and a more fundamental change in economic environment as the economy comes toterms with the end of cheap money, have highlighted just how difficult it will be for DC retirees to navigate investment markets through drawdown, most of them without financial advice.
Delegates at a recent Corporate Adviser round table, Retirement Journeys for Tomorrow’s DC Retirees, examined models for supporting non-advised customers through decumulation, and set out the range of challenges faced by them and the sorts of features they might want.
The scale of the problem Aviva managing director, workplace Emma Douglas said: “The big problem is we will have a lot of people without advice who have a pot of money that will need to last for their retirement, but who don’t know how long that’s going to be. They’ll want some flexibility, but they’ll also want some security, which is a difficult balance to strike. We’re asking them to do a lot of difficult things that are often described as the hardest and nastiest problems in personal finance. Should we really be leaving people to do their own thing when it comes to that? Probably not.”
For Aon head of DC investment James Monk, retaining a level of flexibility is key because individuals’ needs change. “Individuals’ objectives are vastly varied, and although the FCA has made really good steps in providing a structure around the non-advised drawdown market through investment pathways, I do think there are challenges associated with providing structures in a five-year timeframe, or a 15 years in drawdown. Flexibility is the key and albeit that guaranteed income is very expensive to deliver, it does help with retirement planning.”
For Nigel Dunn, partner at LCP, for most people, the problem is too much choice, when decisions are very limited in accumulation. “What we really need is a solution where members don’t need to make a choice and members get to retirement and we say this is what’s going to happen to your pot. You’re going to receive this much tax-free cash, You’re going to receive this much in income. If you don’t like it then you can go and see an adviser. But for the vast majority of people we have put way too much responsibility and way too many options in front of them.”
Hannah English, consulting actuary at Hymans Robertson said individual factors such as longevity needed to be factored in, and made one-size-fits-all solutions challenge. “Men could have life expectancy ten years higher or lower, so having a five-year, or a 15-year solution is hard to turn into a solution that’s going to be perfect for everyone.”
Bad decisions
James Mouland, head of financial planning, UK at WTW said poor decision-making at retirement by those not taking advice is happening for savers with pots of all sizes. “
Even with bigger pots we are still seeing some pretty questionable decisions,” he said. “We are seeing people with £1,000,000 pots taking UFPLS, for example. Now that might be the right decision for that individual – you don’t know their circumstances, but it’s unlikely. Questionable decisions are being made because fundamentally they’re not taking the support that is on offer to them.”
For Isio director Matt Calveley, apathy remains a key challenge to engagement, meaning ready-made solutions are needed. “I think people want a range of off-the-shelf productised solutions, supported by advice. Trying to get people to engage isn’t going to work – apathy will rule. I’m not saying we shouldn’t try, but we need off-the-shelf products to give them.”
Building solutions
Aviva’s Douglas and head of investment strategy and propositions Maiyuresh Rajah set out their organisation’s thinking on designing a new default model for those savers with enough of a pot to want drawdown but not enough to be likely to pay for advice or to be realistically thinking about leaving a bequest from it to their family or friends.
Douglas outlined Aviva’s ‘guided retirement’ solution that splits the pot into three ways – a drawdown pot, a pot for an annuity from age 80 and a small amount in cash for one-off discretionary or emergency spending. “There’s a lot of good behavioural finance reasons for having different pots. And knowing that money is there means you are more likely to spend the other part of your income. We are worried about people underspending in retirement because they don’t know exactly how long they as an individual are going to live. If you have that little bit in reserve, it’s likely to encourage more spending then of the bulk of the money used in the drawdown period,” said Douglas.
Douglas explained that under guided retirement, the drawdown pot is then used to fund the 15 years from 65 to 80 and then the third pot is used for the end-of-life period. She suggested there were two options for structuring this part of the product journey.
“That part of the pot will be either used up front to purchase a deferred annuity that pays out from age 80 or you just set aside that pot and use it at age 80 to buy an immediate annuity,” said Douglas. “The deferred annuity market doesn’t really exist at the moment, which is a drawback to that, that solution. But we are talking to the annuity people at Aviva about how we can make this work.
“Obviously it does work in the bulk buyout world, so it does exist. It just doesn’t really exist in DC. But we are looking at whether we can for, say, the master trust population, buy this bulk deferred annuity.”
Fork in the road
Douglas said deferring the purchase of the later life annuity until age 80 is a less seamless solution, and doesn’t help with the cognitive decline issues of making big decisions later in life. “People might not buy that annuity, but you could argue that that allows you to take account of your health circumstances at that point. Whereas if you buy a deferred annuity at 65 and a group one, your own individual state of health will not be taken into account yet. It’s all part of the pooling.”
Douglas was asked whether, under the bulk annuity bought at 65 option, individuals would be underwritten on health and lifestyle grounds. “You could underwrite but that just adds complexity to the proposition. So it’s a question of can we start with something that is just about right for everybody or avoids the real bad outcomes for people? You come to individual issues where actually people don’t fit into the default, and that’s where potentially education, advice or enhanced guidance can support people,” she said.
Death benefits
Maiyuresh Rajah, head of investment strategy and propositions, UK at Aviva said: “There are trade-offs in terms of what we choose and what we think is the ideal solution won’t have that benefit [death benefits] for the annuity element. As soon as you start introducing things like that, the income numbers start to go down.
“What we’ve seen from research is that members are prepared to put that 20 per cent aside and know that they might not get it back. But the rest of the 70 per cent that’s in the drawdown, and the easy access 10 per cent in cash, that’s all available to you or your estate. So effectively, you’re putting aside 20 per cent and you’re taking that risk with it. But that gives you the ability to have a higher level of income.”
Aviva said they were unable to give specifics on the amount of income that would be recommended as a sustainable withdrawal rate from the 70 per cent pot at this stage, but did feel the 20 per cent figure for the annuity at 80 was the right level to keep the level of income consistent throughout.
Health concerns
Monk said: “There is that percentage of people that, that have a significant life event change in health, cognitive decline through that period of 65 to 80. And that change in circumstance can drive significant decision making. You need that flexibility of that second optionality structure where you have the money which isn’t committed and then you can buy an individual annuity immediately at age 80.”
Douglas agreed it gave flexibility, but pointed out that it did not address the cognitive decline issue. You end up thinking do we have the power of attorney in place and all of those other gruesome things that we don’t like to think about old age, but that do kick in.”
Dunn felt there would be challenges in getting people to surrender 20 per cent of their pot at age 65 for a benefit that might kick in 15 years later. “I think you’ve got the same problem there as if you bought an annuity. Most people think they’re going to die in the next five years.”
Dunn pointed to the QSuper Lifetime Pension model in Australia, a pooled investment that gives death benefits and a spouse or partner income, as a solution that addressed the issue.
English said Hymans Roberson research had shown the tipping point where death benefits become important. “The research found that when pots get to the £250,000 mark people do really start to care about inheritance,” she said.
Rajah countered that while people’s first thought was that they might not like to lock their money away, that soon changed when you showed them the income differential. This solution, he said, was for people below that level, who would probably not want to pay for advice.
Rajah added that the age 65 was not cast in stone, but that the more flexibility that was added, the less could be given out from a value perspective in terms of income.
Rajah said: “At age 65 or whenever they retire, that’s when they’re really thinking about what they want to do with their retirement assets. So one of the things that we’re thinking about is if we can get that decision point around that sort of time, that will make it easier for them to actually make a decision. You let it go and they might not come back to you, they might semi retire, they might go somewhere else, and then you’ve lost the engagement.”
Income target
English quizzed Aviva as to what the income target would be linked to, and whether it would be aiming to beat inflation by a particular percentage. Rajah replied that while it would aim to beat inflation, it would not have an inflation target per se.
“We are telling [the customer] that this is what we think they can take out if they want to try to make sure they don’t run out of money before age 80. If there’s a good year, we might then say, actually, you can take out more. It’s up to you whether you take it,” says Rajah.
“If we have said take out 8 per cent or 7 per cent and they’re taking out 12 per cent and they’ve done it three years in a row, we’re going to say, ‘if you carry on doing this, you’re going to run out way before you get to 80, so you need to think about what you’re doing,” he said.
Dunn countered that this decisionmaking freedom presented a challenge to the Aviva model.
Dunn also quizzed what would happen if after a string of bad years it became apparent that the individual was not going to make it to 80 at their rate of withdrawal. “Are you going to just reduce their retirement?”
Rajah pointed out that that was no different to drawdown, where individuals can pull all their cash out and run out sooner than planned.
Competing withdrawal rates Delegates also reflected on the potential for ranking of ‘safe’ withdrawal rates between providers, with the potential for ambitious withdrawal rates being cited in a bid to attract customers.
Monk said: “You have to be careful not to state too many opinions in that space when it comes to pathways, because there’s too much risk when you’re talking to a workplace governance committee that they’re going to interpret that for their own individual circumstances. It’s one of those things you need to manage.”
Monk also pointed out that there were already wide differences in equity allocation between providers in the bequest investment pathway, ranging from 20 per cent to 60 per cent.
Trust model
Aviva’s plan is to go forward with guided retirement in the master trust rather than in the investment pathway options of its group personal pension (GPP) offering. So is this solution more suited to occupational pension rules than FCA rules?
“There is more freedom currently for a set of trustees to decide what they want to do because they do not have to offer investment pathways. Very few own-trust trustees would want to think about extending their duties past retirement, but master trust trustees do want to do that,” said Douglas.
“TPR have made comments that they’re looking to more closely align with FCA. So we may see investment pathways come into the trust based world, but currently I am hoping that we do keep a bit more freedom to design these solutions in trust and I think investment pathways will evolve as well. So let’s hope we can bring some of this into contract.”
Douglas said Aviva’s current drawdown to annuity option does not sit within the five-year bucket required by investment pathways. Asked whether it was time for a review of investment pathways, Douglas said: “Yes, a review of how successful they’ve been and whether there’s now new thinking in market that we could incorporate. The bit that I hated most about them was the fact that you have to pick one of the pathways because it just felt that that wasn’t right for a lot of people. And the five year timeline – I do understand because it’s hard for any of us to think out beyond five years, but it set a rather arbitrary framework that made it harder to talk about these whole retirement solutions.”
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