As retirement options become a reality for more scheme members, providers must step up to the mark, says David Bird, Head of Proposition Development at Lifesight, Willis Towers Watson
Since the retirement flexibilities came into force in 2015, people have changed the way they use their Defined Contribution (DC) pension accounts. The Financial Conduct Authority’s (FCA) recent Retirement Outcomes Review, for example, found that accessing pension pots early is becoming more common, with 72% of pots being accessed by consumers under age 65 and also found that twice as many pots are moving into drawdown as annuities.
This trend has resulted in default investment options receiving a lot of attention for the pre-retirement phase, but there being less focus to date on achieving the best outcomes for members in their post-retirement phase.
Average pot sizes of those using drawdown is larger than the average for annuity or cashing-in; this is encouraging as it suggests that people are considering their options and many are taking advice to help them find the right solution for their retirement.
With many individuals investing a substantial proportion of their retirement savings in drawdown, how can scheme providers help members get the best outcome from their post-retirement drawdown?
Meeting member needs
NEST conducted research with retirees and developed a blueprint for meeting the needs of their members. Although NEST’s members are not typical of all schemes, the research reveals some powerful insights. It suggests that member needs change as they move through retirement and that this journey requires three types of provision: a cash fund, an income drawdown fund and protection for later life.
NEST proposes some guiding principles and a two-phased approach, with a default investment and income strategy, to help members who are not well equipped to make the decisions for themselves.
When thinking about the member perspective and what they want when they choose to drawdown, it’s valuable to consider what they are trying to achieve and what sources of income they have available. It may be the case that members want an income for life that is stable and increases over time but it is not necessarily the case that this captures what they want from all of their pots in retirement.
For those retiring in the near future, they are also likely to have one or more Defined Benefit (DB) pensions and almost everyone will qualify for a State pension. Members will be asking themselves the question of how each and every pot fits into their needs and the demands on their pot for drawdown will be affected as a result.
Need for advice
The FCA has flagged a concern that members aren’t taking advice at retirement and as they are using their drawdown account. Given the complexity of the decisions facing members in managing their resources over many years in retirement and at a time when it will be hard or impossible to repair any damage from poor investment returns with contributions the concern is well placed. Providers can do a lot more to help by providing tools and information that, for example ensure members understand when their money will run out and by prompting them to think about whether drawdown is still the best thing for them as they get older.
Ensuring a robust risk framework
A robust risk framework is key when designing solutions. One of the key risks for individuals drawing an income is that the fund will run out before the member dies, or ‘exhaustion’ risk. Managing against that risk suggests that a bond strategy on its own will not protect the member against exhaustion. However, we also need to guard against the timing risk. Members who invest in equities and face an investment reverse in the early years of drawdown may never recover from that shock to their living standards. Individuals must utilise their broader flexibility to allow them to weather this downside risk.
Establishing guiding principles
It may be helpful to establish your own guiding principles to use when assessing different strategies for drawdown investment.
These principles should take into consideration what members need, as well as anticipate how they might interact with any other choices and savings an individual might have. They should also take into account what help and advice may be made available to them. The principles might, therefore, cover costs, accessibility to capital, understandability and oversight or governance.
In the future, the need for better drawdown investment strategies will grow and we will have more data about what members need. We should also anticipate that the needs of members will change as DC becomes the main source of retirement income outside of State benefits. Perhaps the one certainty is that the solutions in the near future for drawdown investors will continue to change and adapt to members need.