The flexibility of drawdown
Since the introduction of pension freedoms in 2015, drawdown has become a solution used for much more than just drawing a regular income at retirement. It also meets a variety of other needs, including:
- a home for the remainder of an employee’s pension pot when they take tax-free cash while still working
- splitting withdrawals over a few years to maximise tax efficiency instead of fully withdrawing the pot
- using the pot for one-off withdrawals, when needed, perhaps alongside a defined benefit pension, and
- leaving the pot invested for beneficiaries on death – usually with alternative income, such as a DB pension.
Size of drawdown market
It’s no surprise drawdown is a popular option at retirement. The FCA’s analysis of retirement income market data 1 shows 70% of money going into retirement benefits for the first time (between April 2018 and March 2019) went to drawdown. However, only 30% of people accessing retirement benefits for the first time used drawdown. This reflects the fact that the average pot size for people accessing drawdown is higher than for other retirement benefit solutions.
According the FCA’s data, the most common retirement choice is to fully withdraw the plan – with 55% of people choosing this option. The high proportion is mostly driven by small pots (63% of pots fully withdrawn were less than £10,000). But, surprisingly, 4% of pots fully withdrawn were more than £50,000.
Issues for employees in a workplace scheme
The defined contribution pension market in the UK is maturing. At the same time, the average DC pot size is increasing because of auto-enrolment and the decline of defined benefit schemes. Because of these changes, we expect more people to start using drawdown to access income in retirement.
However, for employees in a workplace scheme, choosing to take drawdown can be daunting. This is especially the case for auto-enrolment joiners – who may have simply stayed in the default fund, paying the standard contribution rate – reaching retirement after little engagement with their plan.
In an auto-enrolment scheme, employees benefit from protections such as strong governance (through an Independent Governance Committee or trustees), a default fund and charge capping. But when they reach retirement, they must make a choice, which will have a significant effect on their future prosperity and flexibility. Often, they must make this choice with little experience of financial products – and they’re no longer protected by auto-enrolment safeguards and governance.
Fortunately, strong regulation applies when people take retirement benefits. Firstly, providers must ask customers whether they’ve sought pensions guidance or advice. If they haven’t, the provider must encourage them to take guidance or advice.
The FCA data 1 shows 75% of people entering drawdown took advice or used Pension Wise guidance. But, the proportion of people not using advice increases for smaller pots – 32% with pots of less than £50,000 didn’t use advice. For people who fully withdrew their pots, 62% didn’t use advice – which can lead to poor outcomes because they may pay more tax than necessary. For example, between April 2018 and March 2019, 1,662 people fully withdrew pots worth more than £100,000 without advice – likely leading to a significant tax liability.
So, even when strongly encouraged to take advice, people often don’t. This will especially be the case for workplace scheme members, many of whom will have never sought financial advice and are unlikely to be willing to pay for it. For example, the 2017 Institute and Faculty of Actuaries Retirement Readiness survey 2 found only 6% of UK respondents had paid for retirement advice. The same survey showed use of advice correlated highly with household income.
Risk warnings and shopping around
After asking whether customers have received advice, firms providing retirement products must prepare questions to enable them to identify risk factors for different customers. The risk factors include health, loss of guarantees, sustainability of income and tax implications – and whether they’ve shopped around.
Shopping around makes sense for customers as it helps them get the best outcome, and those with advisers will have support to do it. It’s important for people buying an annuity because it’s an irreversible choice at a single point in time that could have a major impact on future income. But the position is slightly different for people in workplace schemes with integrated drawdown as drawdown is built into their product, which often offers significant benefits above alternative drawdown arrangements.
Integrated workplace drawdown
Integrated workplace drawdown is part of the scheme, which means employees can access it without transferring elsewhere. It usually lets them stay in the same funds as available in the pension, often on the same charges. Here are some of the possible benefits of staying in the workplace scheme to access drawdown:
- Workplace scheme governance
Employees often still benefit from the strong governance provided by workplaces schemes – either an independent governance committee or trustees.
- Lower charges
Employees may still benefit from the capped charges that applied in the auto-enrolment scheme. Drawdown charges can have a significant impact on future income sustainability. For example, a person with a £100,000 pot, taking £4,000 income each year (increasing with inflation) with a 0.5% a year charge could sustain income until age 90. Another person with the same pot and income, but with a 1.5% a year charge, would see their pot run out at 86. So, income for the person with the lower charge would last four years longer.
- Accessing tax-free cash before retirement
One of the biggest demands is to access tax-free cash soon after reaching age 55, but before stopping work. Integrated drawdown lets employees stay in the scheme, possibly invested in the same funds on the same charges, maintain contributions and manage all pension arrangements in the same place. The alternative for an employee without access to integrated drawdown would be transferring to another drawdown plan (if the scheme rules allowed it), which may mean forfeiting future employer pension contributions.
- Availability of financial education, guidance and support
Workplace schemes often offer financial education and support in the run up to and at retirement. This may include retirement seminars and access to guidance or advice. They are also likely to offer digital tools and support to help drive members to better outcomes.
- No transaction costs when moving to drawdown
With integrated drawdown, employees can stay in the same funds, which means there are no transaction costs involved in buying and selling assets. If an employee transfers their funds to another drawdown arrangement, they will incur these transaction charges.
Don’t underestimate the importance of integrated workplace drawdown
Integrated workplace drawdown can offer significant benefits to employees, compared with moving their pot elsewhere at retirement.
Shopping around still makes sense, and workplace drawdown won’t be right for everyone. But when an employee is thinking about accessing drawdown, their first consideration should be what’s available in the current scheme and what they would lose if they transfer.
And, if you’re an employer reviewing your workplace pension, a modern scheme with access to low-cost integrated drawdown is important to drive good employee outcomes.
Steve Jackson manages Workplace Savings and Retirement proposition strategy at Aviva. He’s currently focusing on improving member engagement to deliver better member outcomes. He is a qualified actuary with over 30 years’ experience in the workplace benefits market with different providers and the Regulator.