Simon Chinnery, Head of UK DC at J.P. Morgan Asset Management, says the pension freedoms have changed the options for retiring investors – and advisers need to update their ideas
The pension freedoms represent a dramatic change in how (and indeed, when) many DC members will access their pots in retirement. With around 85% of plan members relying on a default strategy to get them to a point at which they can retire, there is a clear opportunity for advisers to anticipate their clients’ needs far into the future, particularly if an adviser has a strong understanding of the default fund and the level of savings of a client.
Default fund design has evolved significantly over the years in the UK and following the 2014 Budget announcements. It’s clear that further evolution will be needed, especially around flexibility of design to accommodate changing member requirements.
Currently the most common form of default fund for pension schemes is lifecycle, which mechanistically changes asset allocations over time, normally based on age. When first introduced there was a prevailing expectation for equity investments to deliver an impressive 8% to 10% or more per year, with little attention paid to downside exposure. But times have certainly changed – and prospective retirees need to consider what the objective of their default fund is, i.e. is it to maximise their pension pot, or to maintain their lifestyle at retirement?
We can also learn a lot from our friends over the pond, where target date funds (TDFs) are well established and hold more than USD650 billion of US pension assets2. TDFs employ dynamic asset allocation that changes gradually over time. Compared with lifecycle structures, they may also be more focused on member outcomes, rather than simply on beating a benchmark. Finally, because of their single fund structure, TDFs are intuitive to use and easy to monitor, keeping member experience simple and allowing plan sponsors to focus on encouraging better saving behaviours. As a result, TDFs can be viewed as the next phase in the evolution of the default.
Last year, in the UK, we conducted analysis of 10,000 possible portfolio outcomes1 (incorporating variables such as member contribution rates and changes to rates over time, frequency of salary growth, event and size of post-retirement withdrawals) and identified four main lifecycle ‘glide paths’:
- Adventurous: This structure most closely reflects the asset classes and allocations found in the majority of DC defaults today, and has the highest equity allocation during the pre-retirement period
- Balanced: This maintains a more moderate equity allocation
- Cautious: While the allocation here is even lower. This structure, as well as the above two start out holding mostly equities, and then 10 years from retirement begin to shift to Gilts and or cash, reaching its most conservative allocation at retirement
- New generation: This structure is based on the adventurous structure, but replaces 50% of the equity allocation with a median-performing dynamic growth fund
When compared to the projected outcome of a target date fund solution (in the case of this analysis we used the structure of our own TDF solution, ‘SmartRetirement’) – TDFs were found to best fulfill their outlined objective of maintaining a savers’ lifestyle at retirement, offering the highest percentage of member outcomes above the minimum income replacement target, and the best lowest possible outcome (see chart below).
Whilst we are yet to experience exactly what investors will do in retirement after April in the UK, it is clear the need for advice is greater than ever. Annuities will still be right for those wanting certainty; drawdown is likely to become more popular and cash will be king for others.
For instance, in a recent survey3 we conducted amongst nearly 1,000 UK savers with significant investable assets, more than half (62%) claimed to be seeking some income yet just 44% of them were able to correctly explain the meaning of the term ‘income investing’ – and 79% had never been approached by their adviser to discuss income-generating products.
Packaging all these factors – and many others – up in the run up to retirement and into retirement will be a challenge but also an opportunity for advisers.
It is worth noting; corporate advisers in the US have been dominating the DC space for some time, stepping into the workplace to ensure workers are appropriately positioned for retirement and supporting a corporates’ default investment strategy. In light of the pension changes in the UK, we would expect to see a more US-like model for financial advisers develop here.
If the accumulation default is properly structured to manage the changing landscape – and good advice to the corporate is vital here – then an appropriately risk-managed and diversified portfolio (such as a target date fund) should offer a great springboard into retirement.
Now is the perfect time to help clients look beyond the short-term implications of the pension reforms to their longer-term financial objectives in retirement. The US model of close collaboration between advisers, the corporate and the members has led to an integrated model that our fragmented market would do well to emulate.
1 J.P. Morgan Asset Management, ‘Safely Crossing the retirement finishing line’, July 2014
2 Morningstar, July 2014
3 The J.P. Morgan Asset Management ‘Search for Income’ report is published as an interactive online portal here that allows users to explore the findings by theme and by country