How can trustees drive better decisions at retirement?
Since the introduction of major pension reforms in 2015, all defined contribution (DC) pension scheme members over the age of 55 have had free rein over how they manage their retirement savings. They can choose to withdraw cash, buy an annuity - or opt for income drawdown, where they can to continue to invest and grow their pension savings while drawing down cash as required.
The FCA’s most recent figures 1 show that over 645,000 members accessed their pension for the first time in 2018/19 with 55% of members withdrawing the whole of their retirement pot. Of the pots that were fully withdrawn 90% were worth less than £30,000.
Other key statistics are:
- 48% of pensions were accessed without regulated advice or Pension Wise guidance.
- 37% of individuals had regulated advice
- 40% of members taking regular withdrawals took more than 8% of their drawdown fund as income
While these figures demonstrate members’ appetite for pension freedoms there are some clear indications that members may be falling foul of some common pitfalls:
- Paying too much tax – withdrawing even a modest amount can mean paying too much tax, as the withdrawal is added to other income when calculating the tax due.
- Eroding pension savings – members who take their tax-free-cash early reduce their retirement income by a quarter. While those accessing small pots as cash could be better off consolidating into their best value option and leaving their pension to grow.
- Taking too much income – drawdown rates of 8% are unlikely to be sustainable, leaving people dependent on their state pension when they get older.
- Poor decisions around their investment product – this can result in higher charges and/or poor performance. In the very worst-case members can fall victim to a scam and lose everything.
How can DC trustees approach drawdown?
For many DC scheme trustees, deciding how to approach drawdown requires a balancing act between the needs of scheme members and the scheme’s resources. A handful of single-employer trust-based schemes have chosen to offer drawdown within the scheme, but this is relatively rare.
From a member’s perspective rigorous governance around an in-scheme solution provides confidence that their savings are being well managed. Schemes can offer a consistent ‘to and through’ approach to building up and managing withdrawals from a member’s savings pot, simplifying decision-making and improving communications. Crucially, it means members aren’t left on their own to research a complicated product market and risk making a decision that could erode years of good quality pensions saving.
Trustees are bound by the same rigorous governance requirements for drawdown as they are for accumulation. They must make sure they have a suitable governance framework in place to manage drawdown effectively. Savings must be invested appropriately and offer good value for members.
Good outcomes in drawdown rely on the ability of trustees to deliver these effectively. If a scheme’s drawdown solution is poor, then the outcome for members will also be poor. Many trustee boards have concluded that extending their scope to offer a drawdown arrangement is a step too far.
So, what can trustees do to enable better decision making?
Members accessing their retirement savings without information or guidance are more likely to make costly mistakes.
A first step toward better decision making is a clear communication plan to ensure that by the time members come to retire they:
- appreciate the tax advantages that come from investing in a pension,
- have an understanding of investment risk and returns,
- understand what they might need to have saved to provide an income for the whole of their retirement.
Even if members only understand the complexity of their decisions, they may be more likely to seek the guidance they need.
Guidance and advice
Guidance could come from Pension Wise or other sources such as facilitated retirement seminars. For those members who need advice, trustees and employers may decide it’s appropriate to do due diligence on an advisory firm on behalf of their members. Or to take a step further and make a contribution toward the cost.
Employers can pay up to £500 for advice as a tax-free benefit to members. Additional costs can be covered through deductions from a DC pension as an adviser charge or pension advice allowance. Trustees should check their rules allow adviser payments and their policies around them.
Keeping your options open
Another key deliverable is to ensure that members have access to the full range of retirement options. If the scheme doesn’t offer drawdown how can members access the option relatively painlessly?
The most hands-on approach is for trustees to choose a third-party partner, or partners, to offer drawdown products to members. Possibly in conjunction with financial advice.
This means members aren’t researching the market from scratch. It provides trustees with an easier option than managing drawdown within the scheme, but members can still benefit from trustee due diligence and buying power.
Selecting and monitoring drawdown providers or advisers is not without cost and risk to trustees however, so liability needs to be clearly communicated to members.
For those who decide on drawdown without advice the FCA’s proposal to introduce investment pathways should help members make better investment decisions in personal pensions. We’ll need to wait and see if occupational pensions such as Master Trusts follow suit, or if DWP introduces equivalent requirements for occupational pension schemes.
Members will still need to decide which solution is right for them, but by providing a route to each option the trustees reduce the risk that members will simply cash in their pension as the easiest way to get hold of their money.
Regardless of whether trustees choose to provide drawdown in-scheme, work with preferred providers or leave members to make their own decisions, good quality communications, a holistic approach to pension freedoms and clear ways to access financial advice are vital ingredients.
Members may be invested in drawdown for 20 years or more, so making the wrong decision can easily undo the hard work of trustees in driving performance in accumulation.
Doing nothing really shouldn’t be an option.