With rising reliance on defined contribution pensions, retirees face complex financial decisions. In the latest reports of the Pensions Review, led by the Institute for Fiscal Studies in partnership with the abrdn Financial Fairness Trust, we are reminded why advisers must help clients navigate risks, ensuring sustainable retirement income as new policies and default solutions emerge in the DC pension market.
Private sector employees are increasingly accumulating retirement savings in ‘defined contribution’ (DC) pensions (pension pots that do not guarantee a regular income through retirement).
Since 2015, people over 55 have been able to withdraw money from DC pensions in any way they choose.
As this form of wealth becomes more important, people face too many complex and risky decisions through retirement. This increases the risk many exhaust their private resources and fall back purely on state pensions and benefits, especially later in retirement. Reforms are needed to make the system easier to navigate successfully in order to help reduce this risk.
This is the key conclusion of the latest reports of the Pensions Review, led by the Institute for Fiscal Studies in partnership with the abrdn Financial Fairness Trust. The reports find:
The number of people making complex and consequential financial decisions about their pension wealth in retirement is rising substantially:
- Defined contribution pension wealth is becoming increasingly important. Median (middle) DC pension wealth (for those with some DC wealth) at retirement is set to rise from around £75,000 for those born in the early 1960s to around £130,000 for those born in the late 1970s.
- Unless people have significant traditional ‘defined benefit’ (DB) pension wealth, or they have bought an annuity (an income for life), people face a risk of exhausting their private pension wealth because they have lived longer than expected, and therefore seeing large falls in their income. This is a significant risk: our new analysis shows that, among 66- to 74-year-olds with private pensions, 40% of retired singles, and 45% of couples, would see their income more than halve if reduced to just relying on state support.
Encouragingly, the government is bringing forward a Pension Schemes Bill to help address this issue. It is expected that pension providers will be required to provide default retirement income solutions:
- For many, a ‘hybrid’ solution, in which – by default – people are able draw down on their pension wealth flexibly earlier in retirement, but annuitise their pension (buy an income for life) at older ages (e.g. at 75 or 80), would work well. This has been termed a ‘flex then fix’ model. It would provide a balance between flexibility earlier in retirement and security later in retirement when people are more likely to experience cognitive decline.
- But this kind of default solution will not be right for everyone. In particular, those with significant traditional DB pensions (e.g. if they have previously worked in the public sector) may have particularly good reasons not to want to buy an annuity with their DC pension pot. It may not work well for those with health issues that significantly reduce their life expectancy. Pension providers may well not know whether either of these cases applies.
- Defaults should therefore be ‘soft’, with a menu of alternative options provided to make it easy for people to choose other sensible options.
- Boosting the take-up of advice, guidance or some combination should also be a policy priority. 73% of those in their late 50s with DC wealth in 2021–23 did not recall using any sort of information about pensions and retirement choices in the last three years, and this includes substantial numbers of individuals with reasonably large accumulated pensions.
Bee Boileau, Research Economist at IFS and an author of the reports, said:
‘The forthcoming Pension Schemes Bill is expected to introduce default retirement income solutions. Done well, these should improve outcomes for many, given the risks many face when drawing down pension savings through retirement at present. But key questions remain – in particular, there will be some for whom a retirement income default will not be right. The government and pension providers must ensure that it is straightforward to opt out of whatever new defaults are introduced, and that as far as possible those making these decisions are sufficiently informed and helped.’
Mubin Haq, CEO of abrdn Financial Fairness Trust, said:
‘With a decline in pensions and products that provide an income for life, individuals increasingly bear the risks and complexities of managing their pensions. Financial decisions in retirement will become even more difficult as we age. This is made even more challenging by the myriad number of pension pots many will have to manage. Yet few take up advice or guidance. The current system is clearly not working. Consolidation of these pots and providing defaults on how to draw down retirement income will be essential.’
Royal London’s director of policy Jamie Jenkins comments: “10 years on from the introduction of pension freedoms, now is a good time to review the choices people face in retirement. Few people would suggest a return to any form of compulsory income purchase, but there is a growing need to help people consider how they make their pension pot last through retirement, working hand in hand with the State provision.
“This latest report from the IFS helpfully shines a light on the policy options available, the areas of debate and the trade-offs we need to consider. Rightly, it points to the role of the forthcoming Pensions Dashboard and new developments in the form of ‘Targeted Support’ as part of the FCA’s Advice Guidance Boundary Review, both of which have the potential to be transformative in people’s decision-making at retirement.”
Kirsty Ross, Proposition Director at People’s Partnership, provider of The People’s Pension, said: “In the 10 years since the introduction of Pensions Freedoms, our New Choices, Big Decisions research has consistently shown how older savers struggle with the complex decisions ahead of retirement.
“It has become very clear to the pensions industry that the millions of people who will retire with only defined contribution savings, will need much more support than is currently available.
“It’s important that these solutions provide a sustainable regular income for life, protect against inflation and are flexible. One of the reasons why automatic enrolment has been such a success – helping 11 million more people save into a pension – is that it doesn’t require the individual to make ongoing decisions unless they want to. It only makes sense that this support continues through retirement.”
Claire Altman, Managing Director for Individual Retirement at Standard Life, part of Phoenix Group, comments on the IFS reports as follows: “The retirement landscape has changed dramatically in the ten years since pension freedoms and today’s reports recognise the fact that policy and product solutions are still playing catch-up. Those accessing their pensions have a great deal of flexibility and choice but they are also shouldering significant risks when it comes to making their savings last. These challenges mean that two fifths (41%) of retirees will be at high or medium risk of making poor decisions.[1]
“The report correctly identifies a lack of guaranteed income as one of the most significant challenges for retirees and we agree that blended approaches such as the ‘flex then fix’ model highlighted are part of the solution. Our own modelling shows that a combination of drawdown and annuities can offer an attractive combination of certainty as well as the potential for investment growth.
“As the government prepares to legislate for default retirement income solutions, the paper acknowledges that two of the key enablers are a reduction in the number of small pots and increased access to guidance and advice. Everyone’s retirement will look different so creating a system that enables people to seek support to maximise their income and one which gives them a comprehensive view of their total savings is critical.”
Check out the IFS reports
Policies to help people manage defined contribution pension wealth through retirement and Individuals’ challenges managing pensions through retirement are IFS reports by Bee Boileau, Jonathan Cribb.
