We’ve a long way to go in developing smart retirement income solutions for middle earners

More than two years after the government unveiled it’s ‘freedom and choice’ policy, the pensions industry has yet to catch up completely. Defined contribution schemes looking for smart retirement income options for middle earners are not blessed with a great range of options.

But what should trustees bear in mind when looking for suitable offerings?

Five speed limit

1 RETIREES NEED LONGEVITY PROTECTION…

Although annuities have fallen out of fashion, most members who have built up a modest pot are still attracted by the idea of a regular income stream. Many are also acutely aware of the dangers of running out of money, and the difficulties of managing longevity risk.

People don’t just want cash, they want a regular, dependable income”

Paul Todd, Nest’s (National Employment Savings Trust) director of investment development and delivery, says: “All the research we’ve been involved with and looked at abroad keeps coming back to this fact that people don’t just want cash, they want a regular, dependable income.”

This will involve an element of insurance. Nest’s Future of retirement report proposes blending income drawdown with deferred annuities to achieve this.

2 …BUT AT THE RIGHT PRICE

Research from State Street Global Advisors (SSGA) suggests people are comfortable paying for this insurance. “On the modelling we’ve done, you’re talking about setting aside 20-25% of your pot at retirement, and members we spoke to were ok with that,” says SSGA senior DC strategist Alistair Byrne.

The question of when the deferred annuities would begin paying out is a tricky one”

But the question of when the deferred annuities would begin paying out is a tricky one. Byrne says savers want a product that starts paying out at age 75 or 80, but that this is could push the price of longevity hedging too high.

“There is a big question of whether you go for age 80, because that’s what people want, or age 85 to provide a backstop and reduce the cost of the annuity,” he says.

3 GOVERNANCE IS EVEN MORE IMPORTANT IN RETIREMENT

There is very little appetite to provide this kind of service within trust based schemes.

The lack of safe harbour laws in the UK means trustees are not keen on potentially taking on responsibility for members’ choices in retirement. This, in turn, means schemes will probably end up signposting trustees to decumulation vehicles such as mastertrusts, self-invested personal pensions (Sipps) or insurance platforms.

There needs to be an entity watching over this to make sure it’s sustainable”

Although it is unlikely they will be able to make this a default option, for trustees to be comfortable setting up a ‘path of least resistance’ they must be confident about the vehicles that they offload retirees into.

This means they must be trusted brands that are here to stay, with robust governance procedures. Todd says for many retirees governance will be just as important as product design.

“It’s not just about building blocks, or fancy ways of investing or protecting yourself against longevity,” he adds. “There needs to be an entity watching over this to make sure it’s sustainable and help people make those difficult decisions like what is a sustainable income rate and how to respond to poor investment performance.”

4 NOT EVERYONE WITH A SMALL POT WILL CASH OUT

Nest’s research suggests that many people who the industry assumed would simply cash in their pension might prefer to take a regular income.

The firm looked at the attitudes of savers nearing retirement age with £20,000 or more in their pot, and found that even those at the bottom of the range were interested in securing an income.

The confidence of the saver is more important than the size of the pot”

“There was real surprise about how small the income people’s pots would buy,” says Todd. “But pretty quickly people started to make calculations that £50 a month could keep your car on the road, for example. We haven’t established the floor to this, but it’s a lot lower than people thought.”

At the other end of the scale, the confidence of the saver is more important than the size of the pot, although the two factors often correlate.

5 IT’S NOT TIME TO PANIC… YET

The lack of options that meet the criteria above is not an immediate concern for many trustees. Many schemes are still working on giving members access to the basic flexibilities.

And the fact is that most people retiring with DC pots this year will also have an element of defined benefit provision. This means most members will not suffer – their DB income already gives them longevity protection.

“There are some mature schemes out there, but the real need for these solutions is a few years in the future,” says Byrne.

“So it is reasonable for schemes to say ‘dealing with longevity risk and using deferred annuities sound like good ideas, but they are things we can probably come back to in a year or two years’ time’.”

More than two yearsafter the governmentunveiled it’s ‘freedomand choice’ policy, thepensions industry hasyet to catch upcompletely. Definedcontribution schemes looking for smartretirement income options for middleearnersare not blessed with a great rangeof options.But what should trustees bear in mindwhen looking for suitable offerings?1 RETIREES NEED LONGEVITYPROTECTION…Although annuities have fallenout of fashion, most members who havebuilt up a modest pot are still attractedby the idea of a regular income stream.Many are also acutely aware of thedangers of running out of money, and thedifficulties of managing longevity risk.Paul Todd, Nest’s (National EmploymentSavings Trust) director of investmentdevelopment and delivery, says: “Allthe research we’ve been involved with andlooked at abroad keeps coming back tothis fact that people don’t just want cash,they want a regular, dependable income.”This will involve an element of insurance.Nest’s Future of retirement reportproposes blending income drawdownwith deferred annuities to achieve this.2 …BUT AT THE RIGHT PRICEResearch from State StreetGlobal Advisors (SSGA) suggestspeople are comfortable paying for thisinsurance. “On the modelling we’ve done,you’re talking about setting aside 20-25%of your pot at retirement, and memberswe spoke to were ok with that,” saysSSGA senior DC strategist Alistair Byrne.But the question of when the deferredannuities would begin paying out is atricky one. Byrne says savers want aproduct that starts paying out at age 75 or80, but that this is could push the price oflongevity hedging too high.“There is a big question of whether yougo for age 80, because that’s what peoplewant, or age 85 to provide a backstop andreduce the cost of the annuity,” he says.3 GOVERNANCE IS EVEN MOREIMPORTANT IN RETIREMENTThere is very little appetite toprovide this kind of service within trustbasedschemes.The lack of safe harbour laws in theUK means trustees are not keen on potentiallytaking on responsibility for members’choices in retirement. This, in turn, meansschemes will probably end up signpostingtrustees to decumulation vehicles suchas mastertrusts, self-invested personalpensions (Sipps) or insurance platforms.Although it is unlikely they will beable to make this a default option, fortrustees to be comfortable setting up a‘path of least resistance’ they must beconfident about the vehicles that theyoffload retirees into.This means they must be trusted brandsthat are here to stay, with robust governanceprocedures. Todd says for manyretirees governance will be just as importantas product design.“It’s not just about building blocks,or fancy ways of investing or protectingyourself against longevity,” he adds.“There needs to be an entity watchingover this to make sure it’s sustainableand help people make those difficultdecisions like what is a sustainable incomerate and how to respond to poor investmentperformance.”4 NOT EVERYONE WITH A SMALLPOT WILL CASH OUTNest’s research suggests thatmany people who the industry assumedwould simply cash in their pension mightprefer to take a regular income.The firm looked at the attitudes ofsavers nearing retirement age with£20,000 or more in their pot, and foundthat even those at the bottom of the rangewere interested in securing an income.“There was real surprise about howsmall the income people’s pots wouldbuy,” says Todd. “But pretty quicklypeople started to make calculations that£50 a month could keep your car on theroad, for example. We haven’t establishedthe floor to this, but it’s a lot lower thanpeople thought.”At the other end of the scale, the confidenceof the saver is more importantthan the size of the pot, although the twofactors often correlate.5 IT’S NOT TIME TO PANIC… YETThe lack of options that meetthe criteria above is not animmediate concern for many trustees.Many schemes are still working on givingmembers access to the basic flexibilities.And the fact is that most people retiringwith DC pots this year will also havean element of defined benefit provision.This means most members will not suffer– their DB income already gives themlongevity protection.“There are some mature schemes outthere, but the real need for these solutionsis a few years in the future,” says Byrne.“So it is reasonable for schemes to say‘dealing with longevity risk and usingdeferred annuities sound like good ideas,but they are things we can probably comeback to in a year or two years’ time’.”