As DC scheme members approach retirement age, key actions are needed to ensure they will receive the future income they require, says Matthew Craig
How a contract-based defined contribution (DC) pension scheme helps its members as they approach retirement is a critical test of its quality. This is because members need to decide where to invest, which becomes vital as retirement approaches, and then how to convert their DC fund into a pension. In both cases, good corporate governance is important to ensure staff get the help and support they need.
Because there are no trustees in a contract-based scheme, a governance committee, comprising employee and employer representatives, can oversee its operation. David Millar, pension communications manager at Friends Provident, says: “A governance committee will, hopefully, review the age demographic of its population, determine how many members are approaching key milestone points and communicate appropriately.”
Good communication important
Good communication is especially important as members approach retirement. Employers should use a range of media, such as scheme booklets, newsletters and annual benefit statements, online communications through websites or email, and face-to-face communications such as presentations, seminars and even one-to-one meetings. These methods can be tailored to suit a workforce. For example, in a white-collar environment where all staff have a desktop computer, online communications may work well, but in a mainly blue-collar workplace, face-to-face meetings may be more useful.
Communication should start getting staff to think about retiring about 10 years before their planned retirement age. Gurmukh Hayre, head of DC at KPMG, says: “At this point, people need to think about where they are invested and if it is appropriate for them and their time horizon to retirement.”
Neil Davies, head of corporate marketing at Aegon, adds: “At this time, the messages will likely be around consolidation of pension pots or reviewing their investment choices to ensure they are not in overly risky funds.”
Assess de-risking process
The de-risking process – moving DC fund assets into less volatile assets as retirement approaches – should be assessed as part of the corporate governance of a DC scheme. A lifestyling investment strategy is often used, with members’ funds gradually shifting from growth funds to less volatile funds, such as cash and bonds. Lifestyling normally happens over a fixed period leading up to the assumed retirement age, with automatic fund switching each month or year, but this may not suit all members. The start of a lifestyling strategy should be a trigger point for pre-retirement communications to ensure it is still valid for individual members. Helen Dowd, principal at Aon Consulting, says: “A member might not want to retire at 65 or they might be thinking about using income drawdown and lifestyling does not suit that.”
If staff do not find out the lifestyling process has begun until they receive their annual benefit statement, it is not too late for them to act, but it is not ideal. “Typically, members will receive communications about retirement about six months out,” says Dowd. “That ticks the box from a regulatory perspective, but it is not really enough.”
Consider annuity purchase
As members get closer to retirement, communications need to push their thinking from the overall investment strategy to the details of an annuity purchase or other means of converting a fund into a retirement income. This is a critical stage and good governance is needed to ensure a DC plan provider, the sponsoring employer and scheme advisers work together well. The process needs to inform members of their options and help them understand them.
Helping staff with retirement planning can be seen as the culmination of efforts to educate them throughout their membership. Rosanne Corbett, senior consultant at Mercer, says: “Effective pre-retirement communication and processes are critically important tasks the employer as sponsor and the insurer as provider of the contract-based scheme should take extremely seriously.”
Mercer provides a DC barometer tool that looks at the impact of the movement in annuity rates, investment markets and contribution rates, says Corbett. “This information is used to illustrate how a member’s plans for retirement might improve or worsen over time and the months or years fewer or longer that they might have to work to achieve a desired retirement income.”
DC providers will automatically send out information to staff approaching retirement on options such as annuity purchase, phased retirement or income drawdown, but communications that rely on members to understand and make their own choices may not be enough. Aegon’s Davies says: “We have found running workplace presentations can be an effective way of communicating retirement options with members, although these do not go as far as giving advice.”
Retirement counselling sessions
]Retirement counselling sessions run by an external provider can help to give staff a more holistic view, by including lifestyle issues, such as relationships. “There is a spike in divorce rates when people retire, as couples do not always cope well with change,” says Dowd.
Although a holistic view is important, a contract-based DC scheme should review its processes for annuity purchase if it wants to follow best practice. This is because there can be a big difference – as much as 30% – between a standard annuity offered by an existing provider and the best open market rate. Adam Stevenson, DC team, senior consultant at Towers Watson, says: “Is the current contract-based provider doing anything wrong? Is it trying to highlight the benefits of the open market option?”
Employers that want to follow best practice should ensure their providers do not rely on member inertia to sell them an uncompetitive annuity. One way to change this is to involve an independent annuity specialist that can source competitive quotes for members, or to choose a DC provider prepared to give its own annuity rate as well as three or four quotes from competitors.
Members may also get a better annuity rate if their health or lifestyle, through factors like smoking, qualifies them for an enhanced rate. Stevenson says up to 50% may qualify for enhanced rates, but not enough take them up because they think they will be penalised by declaring poor health.
Independent advice needed
Given the increasing range of annuities and other available options at retirement, financial advice may be needed. This can be important for more complex retirement income options, such as phased retirement or income drawdown. Employers can facilitate this by directing staff to an independent financial adviser or by subsidising advice.
Staff should also understand how independent advice is paid for – either by an upfront fee or from commission on any products sold. Individuals may baulk at paying a fee themselves, but commission would come out of their pension fund.
In a contract-based scheme, the provider is responsible for communicating with deferred members. Although an employer may not be legally responsible, it may feel more comfortable if its DC provider takes its responsibilities to deferred members seriously.
Good corporate governance for members approaching retirement rests on employers taking their responsibilities seriously. By communicating and engaging with members, employers can help staff preserve their pension as they near retirement and make the right choices on taking an income.
Key issues to consider for contract-based members around retirement
- Employees should join the pension scheme at the first opportunity.
- They should increase contributions when they can afford to do so. Automatic increase structures are ideal.
- If staff do not use a lifestyling investment strategy, employers must ensure they start to de-risk at an appropriate time.
- Hopefully, any lifestyling option will stabilise the asset allocation to 75% bonds and 25% cash six months before the expected retirement date.
- The bond portfolio should match the expected annuity type. For example, corporate or fixed interest for a level annuity or index-linked gilts for an escalating annuity.
- Annuity ‘shapes’ (single/joint life, exact type of escalation, guaranteed periods, what to do with lump sum) should be looked at 12 to six months before expected retirement date.
- Annuity providers should be selected using the open market option.
Good governance can help with this by:
- Ensuring governance committees hold pension managers or providers accountable for member communication about issues within appropriate timeframes.
- By considering plan metrics and adjusting communications accordingly. For example, if everyone decides to stay in equities until retirement, the communication is probably not working.
- By ensuring members make full use of open market options at retirement. Source: Andrew Cheseldine, Hewitt Associates benefits of good governance
Source: Andrew Cheseldine, Hewit Associates
Benefits of good governance
- Improved perception of the scheme can lead to better employee retention rates.
- Early identification of administrative problems can save costly fixes later on.
- Monitoring the charges and competitiveness of the scheme makes sure employers have the right scheme for the company’s needs.
- Improved employee engagement limits the number of member complaints.
- Qualifying schemes can use the National Association of Pension Funds’ quality mark, so their governance arrangements can gain national recognition. Source: Rosanne Corbett, senior consultant, Mercer
Source: Rosanne Corbelt, senior consultant, Mercer
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