Thought Leadership

Pensions Newsletter - Summer 2014: ‘Welcome’ Budget reforms likely to prompt change at DC schemes

Trustees, sponsors and their advisers overwhelmingly support the pension liberalisation announced in the Budget by the Chancellor, George Osborne,  and are likely to change their schemes as a result, according to a survey of attendees at our recent Defined Contribution Conference.


Trustees, sponsors and their advisers overwhelmingly support the pension liberalisation announced in the Budget by the Chancellor, George Osborne, and are likely to change their schemes as a result, according to a survey of attendees at our recent Defined Contribution Conference.

More than four-fifths of respondents believe the increased flexibility will be a good thing for defined contribution (DC) pensions (Figure 1). Many delegates saw the changes as lifting burdensome restrictions which would make pensions more attractive. One said: ‘Annuitisation has always smacked of the “nanny state”, and the previous limits on minimum guaranteed income … were unreasonably harsh.’ Other typical comments were that ‘things needed a radical overhaul to increase member confidence and engagement’ and ‘the working population will soon come to realise that pension contributions are no longer “dead money” but readily realisable savings for their future which they can use for their benefit.’

However, among the few dissenters,there were concerns that the changes may encourage people to make the wrong choices at retirement. One or two highlighted the mixed messages sent by the moves. According to one attendee, they ‘conflict with auto enrolment [and] take the focus away from the true problem: the guaranteed funding of old age.’

Nonetheless, approaching 90% of our respondents believed that DC schemes would now have to provide multiple default strategies to cope with the new post-retirement landscape (Figure 2).

There was a general view that schemes would need to accommodate the new freedom to choose between annuities, cash and drawdown. However, one comment was that this would ‘add to the complexity from a member’s perspective, which is not ideal. Member communication is going to be even more important’. Some pointed to the need for more financial education. But of the few who disagreed, many pointed out there could be only one default; having more would be difficult to manage.

Not surprisingly, there was also a big majority of respondents who thought that they would need to look again at the default investment strategy of their schemes in the light of both the Budget and the announcement that the government will cap charges at 0.75%. Several attendees thought they would now need to review existing default approaches which assumed that members would buy an annuity. On the whole, the charge cap seemed to be less of an issue with respondents. For instance, our sample was evenly split on whether the cap would lead to fewer ‘outcome-based’ investment solutions being used in DC schemes.

There was also uncertainty over the future of annuities. Only a slim majority believed that they would continue to have a role in retirement planning at the point work stops in the wake of the Budget changes (Figure 3). Even so, quite a few attendees believed the certainty of a regular income would continue to appeal to retirees, albeit perhaps once they were a little older. One comment was that: ‘When it is optional, an annuity is likely to be seen as more valuable.’

Osborne throws down a pre-retirement challenge

The Chancellor, George Osborne, has fundamentally changed the pensions landscape with his Budget announcement heralding the lifting of restrictions on how pension savings can be spent. The removal of the old presumption in favour of annuities means, we believe, that ‘pensions’ will increasingly be seen less as a way of creating an income in retirement and more as a flexible savings vehicle, as they are in the US.

Trustees and others involved in defined contribution pensions are clearly bracing themselves for the challenge. An overwhelming majority is now expecting to have to offer multiple default approaches for members in the last stages of their career before retirement (see our survey on page 1). We believe that reflects the confusion now evident. There is no longer a single route to retirement. Defaults will have to match the freedoms members will have over their pension pots – take the cash, move into drawdown, buy an annuity or use a combination.

Flexibility will be crucial for most older members in this new environment. They will need to preserve their wealth as they approach retirement to give them the widest range of options when work stops. Any default fund will therefore need to offer fairly solid protection against unwelcome market falls – after all, a member approaching retirement would find it hard to recover from losses such as those experienced in 2008. But to truly preserve wealth, his or her fund will also need to combat the corrosive effects of inflation. So the member may have to accept some member may have to accept some beating growth they need (see chart).

Our research suggests that such an inflation-plus target should be entirely achievable using a low-risk, diversified multi-asset portfolio. By adding a variable volatility overlay (see our last Pensions Newsletter for further details), we think it would be possible to provide a mechanism aimed at putting a floor under losses.

Of course, some members may know in advance that they will want to buy an annuity. They may have paid off their mortgage or expect to realise cash from other sources. For them, a fund that removed some of the uncertainty about the level of annuity they could expect might provide peace of mind in the run-up to retirement. We believe a portfolio built around an intelligent gilts-based benchmark that reflected the expected annuity cash flows of these older members would give just the reassurance they need.

Whatever individual members decide, we believe the Osborne reforms could provide a much-needed spur to pension saving. Now both providers and trustees need to rise to the challenge, starting a conversation to see how new investment solutions can create the sort of defaults that members need to exploit this new environment effectively.

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