Saving for retirement is a largely hands-off experience for UK workers.
Auto enrolment nudged millions into workplace pensions — undeniably a great thing, though most still aren’t paying in enough. But they never have to make an active investment choice, as their contributions are automatically swept into their provider’s default fund.
As workers get older, the assumptions increase. Unless they say otherwise, those saving into defined contribution (DC) pensions will often gradually be “lifestyled” away from risky equities and into bonds. This reflects an out-of- date assumption that most people will buy an annuity when they retire.
Having been left to their own devices for decades, everything changes at the point of retirement. Suddenly, people can access more money than they’ve probably ever had in their entire lives! The problem is, how will they make it last for their remaining years?
Managing a drawdown pot so you don’t run out of money before you run out of retirement is challenging, even for engaged and experienced investors. To help address this, the government’s forthcoming pensions bill will require schemes and providers to set up new “defaults” to shape the way people take their pensions if they don’t make active decisions.
The ink won’t be dry on this until the summer and there’s a huge amount of work going on behind the scenes in the pensions industry as providers fathom different ways of doing this. Guiding members through the process of spending their assets is going to be far more complex than co-opting everyone into a workplace pension.
Pension providers I’ve spoken to this week are targeting their “default” solutions at unadvised customers with a total pension pot worth between £50,000 and £250,000 on top of the state pension.
“The problem at the moment is that there’s surprisingly little information about how people want to take their pension in retirement,” says Sir Steve Webb, former pensions minister and partner at LCP, the actuarial consultancy.
Customer research suggests the biggest issue people grapple with is working out a “safe” amount to draw down from a finite DC pot when they don’t know how much longer they might live. And while most customers say they do want to take a regular income from their pension in retirement, they also say they don’t want to buy an annuity, as they value flexibility.
Yet defaulting retirees into income drawdown risks running counter to existing defaults. Why lifestyle older workers into lower risk funds in the run-up to retirement, only to switch them back again? Providers must ensure what happens pre-retirement joins up with post-retirement products that they are now designing.
To make this task harder still, people’s spending needs are likely to fluctuate as they age. Will most people want to frontload spending in the “go-go years” of early retirement; dial it down for the “go-slow years” as they become less active, or keep more back for the “no-go years” when care costs could spiral?
To help answer this question, Webb and researchers at the University of Bath have analysed 50 years’ worth of pensioner spending data in a report called Downhill all the Way. The biggest predictor of retirement spending patterns? Whether you are renting in retirement, or own your own home.
The analysis found that pensioners who rented tended to have very flat real spending throughout retirement, with much less spent on luxuries. However, wealthier homeowners strongly frontloaded their spending — a trend that forthcoming inheritance tax changes to pensions could intensify — though it dropped off sharply in real terms as they aged.
Segmenting the different groups even further, other significant factors included a person’s health; whether they were single or part of a couple, and what level of other assets they (or their spouse) might have.
“This means that pension providers should not have a one-size-fits all default, but should try to find out more about their members and understand the profile of spending they’re likely to need before allocating them to a default pathway,” urges Webb.
This sounds easier said than done, but I was fascinated to see how Aviva, one of the UK’s biggest pension providers, is designing a tool to help customers envisage their eventual retirement pathway.
This will involve splitting a DC pension into three broad buckets, which are then invested accordingly. First, a pot to finance occasional spending. Next, a flexible drawdown pot to meet everyday spending needs (alongside the state pension) until they reach a certain age. And last, a guaranteed income pot that sets aside funds to buy an annuity when they reach that point. Another important factor is how cognitive decline could impact a person’s ability to manage their investments in later life.
Other providers such as Standard Life are experimenting with modelling tools to help retirees work out what they might get from the state pension; how they might cover their essential spending by using part of their DC pot to buy an annuity and then flexibly access the rest.
Rather than being defaulted into a “set and forget” style decision, providers seem keener for customers really to engage with this process on an ongoing basis. But for that to happen, the financial regulator will need to hurry up and complete its ongoing advice-guidance boundary review.
Now, talking to customers about their circumstances is restricted to the most banal of conversations lest this is construed as advice. In future, this could enable much more targeted support, including warnings if they were withdrawing funds at what is deemed an unsustainable rate.
The fragmented nature of the pensions market is another issue. I could have £50,000 in one DC pot, and £500,000 in another. How are providers supposed to factor that into defaults? We can only hope the long-promised pensions dashboard, which will allow savers to see all their retirement savings in one online place, will help with this.
When it is easier for people to track down and consolidate small pensions into fewer big ones, there’s a golden opportunity for providers with the best tech, tools and customer-facing solutions.
But let us be realistic. Whizzy technology alone will not solve the problem of pensions under-saving. My final hope? That we can somehow default people into engaging with their potential retirement pathway at a much earlier stage when there is still time for more of them to do something about it.
Claer Barrett is the FT’s consumer editor and author of the FT’s Sort Your Financial Life Out newsletter series; claer.barrett@ft.com; Instagram and TikTok @ClaerB
https://www.ft.com/content/7cff150d-3391-4a7e-9b18-7c23794f519a
