Steven Charlton, DC proposition manager, at Vanguard Europe explores the key lessons that the UK can learn from around the globe
1) Thinking about the end at the start
It may sound odd, but one of the main lessons we’ve learnt from our defined contribution (DC) experiences around the world is to build the end at the beginning. This means focusing as much on designing the income stage as on designing the accumulation stage of a pension scheme. However, trustees, employers and scheme providers need to be aware that will entail a new layer of responsibility for them.
As it stands, the retirement income stage is still being finessed, even in countries where DC is well established, for example the US and Australia. And no one has come up with an ideal solution for DC. There is also a key lesson here for legislators and regulators. They need to understand the effect their rules can have on product development and member behaviour, especially whether certain taxes act as an incentive or disincentive.
2) Good scheme design and education to help members reach their retirement goals from US and Australia
Good scheme design refers to the use of defaults or automatic features that help steer members to good outcomes. Automatic features such as auto enrolment and auto escalation have helped improve participation and savings rates in the US and Australia.
A well-designed scheme should encourage members to contribute, increase their contributions and invest wisely. And these lessons need to extend to the retirement income phase too.
But along with good scheme design, we also need education resources for and constructive engagement with members so that they know what their options are and how to decide between them. This could be web-based tools, which we see in the US, that illustrate how different savings and asset choices will affect how much accumulates or how different spending patterns in retirement affect the pot.
3) The success of target date funds (TDFs) in the US
Selecting TDFs as the default option is a good example of how a scheme can improve member outcomes. Our research in the US shows that, in aggregate, the use of TDFs leads to better diversified portfolios and better investment outcomes compared with investors who make their own investment decisions.
Behavioural finance tells us that often when faced with challenging decisions and a lot of choice, people are paralysed with indecision. Thoughtfully designed defaults – such as TDFs – make sense, especially for those without the knowledge, interest or time to asset allocate, rebalance and trade in portfolios.
These barriers to achieving good investment outcomes are eliminated with TDFs. Those complex investment decisions become the responsibility of experienced investment professionals.