Rising to the challenge of the Budget
This year’s Budget has revealed a fundamental inconsistency at the heart of government pension policy. The explicit message sent out with the decision to liberalise post-retirement income options is that people can be trusted with their own money – if you splurge your savings on a Lamborghini, that’s entirely up to you.
This year’s Budget has revealed a fundamental inconsistency at the heart of government pension policy. The explicit message sent out with the decision to liberalise post-retirement income options is that people can be trusted with their own money – if you splurge your savings on a Lamborghini, that’s entirely up to you. Yet this seems completely at odds with the ethos behind auto enrolment, a policy which created a rare consensus in pensions policy between political parties, employers and trade unions that people should be ‘nudged’ into saving. It seems that, having spent all that effort over the last few years in encouraging people to take the right decisions at the front end, we now seem to be abandoning them at the back end.
It looks suspiciously as if nobody has thought this through properly. But we are realists. And the reality is that, having opened the door to freedom, it will be politically well-nigh impossible for the Chancellor of the Exchequer, George Osborne, to slam it shut again.
So the question now is: how do we guide people towards making the right decisions in this new environment? One way is to talk to them direct. Mr Osborne has promised that defined contribution (DC) pensions members will be given access to ‘free and impartial, face-to-face guidance’ on the options available to them at retirement. This commitment raises a whole host of questions. Quite apart from who will deliver the advice, there are the issues of when it is to be given and what its objectives are to be.
Ideally, members would need to be guided – and, arguably, properly advised – well in advance of them retiring, say in their early 50s. Such ‘guidance’ might simply lay out the three main options now open to the individual at retirement – take their savings as cash, move into drawdown or buy an annuity. They could then direct their own savings appropriately. But even if members were inclined to act, by 65 such advice is likely to come too late. The fund in which they had been saving their contributions for several years by then may have been designed to arrive at a quite different destination to the one they ultimately want. And, of course, even the best guidance given in plenty of time may not suit an individual’s circumstances or preferences forever.
We think the benefits of guidance given en masse to DC members are likely to be limited. Far better, we believe, to direct members’ savings towards a default fund (or funds) designed to provide the optimum outcome when they retire, whichever route they ultimately take. This default could take the form of a fund aimed at preserving wealth in the last few years of work, or it could have the narrower remit of tracking the annuity the member might eventually buy when they retire.
Longer term, a more satisfactory solution might be to provide a default fund that continued through retirement, seamlessly changing from being a savings builder to being a savings payer. Indeed, using a drawdown approach combined with an insurance contract, the pensioner could use such a vehicle to defer buying an annuity until an older age when rates become more advantageous.
So we believe that employers, trustees and providers need to rise to the challenge of the Budget. The government’s liberalisation of the DC post-retirement market has effectively removed the previous default position for retirees. We must therefore work together to provide innovative new default approaches that can replace the old regime and give even greater peace of mind to members.
To discuss the themes in this article further, please contact Stephen Bowles, Head of UK Institutional Defined Contribution at Schroders, on +44 (0)20 7658 4916 or email email@example.com.
Schroders is a global asset management company with £268.0 billion under management and an international network spanning 37 offices in 27 countries. We have significant experience of managing DC assets and of helping scheme managers, trustees and sponsors to operate pension schemes efficiently. We manage assets for DC pension schemes in the UK and also have relationships with institutional investment platforms. With more than £36 billion in assets, managed on behalf of both defined benefit and defined contribution pension schemes in both the corporate and public sector, UK pension funds form a significant proportion of our global client base.
Source: Schroders, at 31 March 2014.
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