Automatic-enrolment has been extremely successful and there are now 13.5 million people who are active members of a pension scheme, according to the Office for National Statistics’ (ONS) Occupational pension scheme survey, published in September 2017. This means that employers are making a substantial contribution to many workers’ retirement aspirations. While most employers know how to support their workforce as they build their retirement nest egg, the situation is less clear when the employee must convert their pension pot into retirement income.
Let me explain. Prior to the introduction of the pension freedoms in 2015, the vast majority of people used their defined contribution (DC) pension pot to purchase an annuity which was designed to provide them with a guaranteed income for life. Depending on the type of product they chose, they might get a better or worse rate but the employer knew that it was a relatively low-risk decumulation option; especially when complemented by defined benefit (DB) pension income.
Freedom and choice
The advent of the pension freedoms has changed this and people now have significantly more choice as to how they access their retirement savings. Purchasing an annuity is still an option but so is myriad other new choices. While the freedoms are to be welcomed, it is challenging for employers and their employees because, sadly, people find pensions far less interesting than Game of Thrones.
To measure this evolution, the Financial Conduct Authority (FCA) published the Retirement Outcomes Review: Interim Report in July 2017. It found that accessing pots early, that is, prior to traditional retirement age, had become the ‘new norm’ with over half (53%) of pots accessed having been fully withdrawn. It also noted that most consumers (94%) who had fully withdrawn their DC savings had other sources of income in addition to the state pension, highlighting that this may become a problem in the future when this is not the case. The relative popularity of drawdown is also growing and the FCA noted that the market is still developing as consumers are continuing to adjust to the reforms.
Looking to the future, it highlighted a selection of emerging trends that it felt needed further consideration, including the worrying view that individuals who fully withdrew their pots did so partially because they did not trust pensions. It also noted that annuity providers were leaving the open market and product innovation had been limited.
Finally, it pointed out that most individuals chose the ‘path of least resistance’: accepting drawdown from their current pension provider without shopping around and that many individuals buy drawdown without advice but may need further protection to manage it effectively.
To remedy these concerns, it invited industry to respond to the consultation, focusing on how individuals who purchased drawdown could be protected, competition could be encouraged, and tools and services to help consumers make good choices could be developed. The consultation closed on 15 September 2017 and we expect the final report to be published within the next year.
Employers need to provide guidance
So, what do employers need to know? Firstly, it is natural for employees to look to their employers for guidance, advice and assistance at retirement so HR departments need to be in a position to respond to this need. Employers are not allowed to provide advice, but they are allowed to point employees in the direction of resources such as The Money Advice Service (MAS) and explain terms that people might not understand.
Secondly, 84% of retirees say they want an income from their pension savings but, for those who cannot, or choose not to, engage with complex financial choices, there is no easy or obvious way for them to find a good-quality product. One suggestion that we included within our response to the consultation was that pension scheme trustees should be able to select appropriate income products and signpost them to their members. If this, or a similar scheme, comes into being, employers are likely to need to provide either financial or communications support as part of this.
Until the final report is published, it is difficult for employers to know what steps they will need to make. However, it is safe to say that employers need to consider how they can help employees make the most of the freedoms in a safe sustainable way.
Nigel Peaple is deputy director DC, lifetime savings and research at the Pensions and Lifetime Savings Association (PLSA)