Welcome to this latest in our ‘mini-series’ of blogs on current issues facing defined contribution pension schemes. In this edition, with Rebecca McKay from Trowers & Hamlins, we are looking at how DC members might be missing a trick when it comes to flexible retirement planning, and what their schemes can do to help.
“The reports of my death are greatly exaggerated” is the alleged text of a cable sent by Mark Twain after his obituary was published, mistakenly. Could the same sentiment now apply to annuities, whose demise has long been predicted, particularly since flexible retirement options were first introduced in 2015? Are annuities dead, or should we be reassessing the important role they can play as a constituent element within a balanced retirement income package that DC members are likely to need in the years to come?
It is not difficult to see why anti-annuity sentiment still predominates: according to HMRC, in the first quarter of 2021, £2.6bn was withdrawn flexibly from DC accounts, a 6% increase compared to Q1 2020. By comparison, in 2020 the top ten annuity brokers processed only £610m in annuity purchases covering approximately 9,500 cases, which suggests that there is little current appetite for guaranteed income streams.
It doesn’t help that those wanting to annuitise often fail to source optimum terms by not shopping around and missing out on the enhanced terms available for those with lower life expectancies. More worryingly, too many are still purchasing an annuity without sourcing regulated advice and / or speaking with Pension Wise. How is it that meerkat-themed marketing can work for car and house insurance, but not retirement income? Perhaps we shouldn’t ask.
Underpinning this shift in sentiment, in recent years many DC schemes’ default funds have been recalibrated to target drawdown and/or ‘universal’ retirement options, at the expense of annuity purchase. We should also not forget the increased prevalence of equity release, which is increasingly being used to provide additional ‘income’ in retirement: figures from the Equity Release Council show that in the first three months of 2021 £1.14bn was released by c16,500 customers. Wither annuities, in the face of cash in hand?
The main issue here may be psychological: as Laurence Kotlikoff, (a professor of economics at Boston University), once said, “In retirement, the risk is not dying, but living beyond average life expectancy”. Despite strenuous efforts by trustees, corporate sponsors and providers, DC members invariably know little about how their scheme works. If ignorance prevails, loss aversion will continue to play a significant role in retirement decision making, characterised by the need for ready cash and/or to retain control at the expense of consistency.
We haven’t yet reached the point at which DB payments no longer underpin retirement income streams, but that day is not far off, which will leave an impending cohort of ‘pure’ DC retirees whose only source of guaranteed income is going to be the State Pension. Other than the alternative sources flagged above, what can be done to meet this potential requirement - whisper it quietly, could this void be filled by annuities?
Here it would be useful to start by reminding DC members that there is a genuine alternative/supplement to drawdown, in the form of fixed term annuities, which allow members to keep their options open without committing to a lifetime annuity. Fixed term income levels can be chosen over a set period, with no investment risk. In the event of death within the selected term, beneficiaries can receive the remaining income payments or the value of the fund, less any income taken prior to the date.
A 70 year old with a £100k DC pot could currently generate an annual income of £8k pa with a guaranteed maturity amount of just under £30k (i.e. total income of just under £110k) compared to a ‘normal’ income of just over £5k pa*. Could a £100k drawdown fund currently support an 8% pa withdrawal rate and maintain equivalent momentum? Nobody knows, but LCP research on safe withdrawal rates provides food for thought on this issue. Perhaps annuities aren’t as ante-diluvian as some would believe: if they are used at the right time and in the right sequence, annuities can offer the comfort blanket of a guaranteed regular income at the point when managing a drawdown account is perhaps not as easy, or future expenditure patterns are more predictable.
The FCA’s investment pathways might help members to make better choices, but given what we already know about the extent to which members are likely to be proactive in assessing their options, trustees and scheme sponsors are going to come under more pressure to justify what their scheme offers in terms of retirement planning, and to demonstrate that they are helping members navigate these really tricky decisions.
If retirement options are no longer binary in terms of being taken at a fixed point in time and manner, this means that trustees and scheme sponsors, as a minimum, are going to need to manage member expectations by providing access to advice and guidance to help members achieve the optimum retirement strategy. Fighting shy of involvement on this issue is no longer an option, so is there a legal risk if trustees don't get involved?
The key question is who may (or will) be held accountable if DC members run out of money. As this may become a reality for many in the coming years, lawyers are anticipating claims: the magnitude of the issue means the legal position is ripe for development, and in the context of their broad fiduciary duties, trustees are surely an obvious target (employers also could be within scope). As mentioned in one of our previous blogs, employees increasingly expect financial (including retirement) support from employers.
One potential recourse that members could take is that the trustee and/or employer failed to provide sufficient information to enable informed choices at retirement. Or that the support given didn't give the full picture and members were inadvertently led in a particular direction that wasn’t the best option for them. For progressive schemes and employers, as well as avoiding any potential claims, getting involved is an opportunity to add value meaningfully to the decision-making minefield facing this DC generation. If you get this right, it could be a "win/win" for all.
So what next? We know the ‘twain’ can meet, particularly for future DC members who will be entirely reliant on DC pension savings and need to be aware that their retirement income options don’t have to be an either/or decision.
They can have both – we just need ‘Sergei’ to promote this!
(*source: Retirement Line)