Who or What is to Blame for the Plight of the U.K.’s Defined Contribution Retirees?
March 5, 2020 — London
The issues include a lack of innovative products and poor education
Five years on from the introduction of the U.K.’s pension freedom and choice legislation, defined contribution (DC) scheme members are still being underserved by the market post retirement, according to the latest The Cerulli Edge―Global Edition.
Since 2015, individuals have been able to access their pension pots as they see fit from the age of 55, with no requirement to buy annuities. More than 350,000 DC savers—equivalent to 55% of those accessing their pots in the financial year 2018/19—withdrew their entire fund the first time they accessed it, according to the U.K.’s Financial Conduct Authority (FCA).
The investment industry (advisors and providers), the government, and employers are under pressure to build a framework that allows people to make the best decisions as easily and cost effectively as possible. This is, however, proving difficult, notes Cerulli Associates, a global research and consulting firm.
“Auto-enrollment, persistent low interest rates, the role of the state pensions, and even the fallout from Brexit are still yet to play out, so their influence on the DC market is not fully understood,” says Justina Deveikyte, associate director, European institutional research at Cerulli. “Attempting to build a framework that meets the needs of today's retirees as well as those of future pensioners could undermine stability.”
The FCA believes that the market is failing to innovate. It accuses providers of offering complex products that lack transparency and flexibility; providers reject this criticism.
In addition to the challenges of catering to a mass market with a multitude of needs and experiences, the U.K. is still managing structural issues that make innovation difficult. Defined benefit assets still dwarf those of DC, education levels remain low, tax rules undermine some pension legislation, and large numbers of pension members remain disengaged.
Just less than one-third (30%) of those individuals qualifying for freedom and choice in 2018/19 took flexible income while keeping the pot fully invested, according to the FCA. And the range of drawdown products on offer has grown significantly since 2015.
However, simply offering drawdown products that fail to address the many risks associated with investing in a pension pot at the same time as withdrawing income may be the source of the FCA’s frustration at the lack of innovation, says Cerulli.
“A key challenge of drawdown is sequencing risk, where poor or negative returns hit the fund early in decumulation and hinder the ability to draw income. Another challenge is being able to correctly gauge the amount: taking too much or too little income means either running out of money or dying with plenty still left behind,” says Deveikyte.
It could be argued that the existing products can counter these risks, but that savers need help understanding the differences between the products and what they are designed to do.
The FCA believes that issuing investment pathways would improve the at-retirement market. Pathways force drawdown providers catering to the unadvised market to offer four options: to leave the money where it is, to purchase an annuity within five years, to start taking money as a long-term income within five years, or to plan to cash in all the money within five years.
However, the response of providers to pathways has been lukewarm. They argue that the regulator has given scant detail on how to offer them and that, until there is more direction, the pathways may not serve their purpose.
Seamless transfer from accumulation to decumulation is another area still lacking for DC savers. Occupational scheme members, whose employers are unable to offer post-retirement products, are obliged to move out of their funds and into entirely new products. This takes time and incurs costs.
“Until DC pots grow large enough to provide attractive commercial incentives to providers and until savers want to engage with and pay for advice and products, product suitability will remain inconsistent,” says Deveikyte. “The regulators and policy-makers must force providers’ hands and individuals and employers need to apply pressure of their own if the at-retirement market is ever to reach its full potential.”
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