THE END OF PENSIONS? Consultants Corner

Transcription

1 THE END OF PENSIONS? By Charlotte Moore It s no exaggeration to call the pension changes announced in this year s Budget revolutionary: this reform could herald the end of pensions and usher in a new era of lifetime savings. We held a roundtable discussion with a group of select consultants at State Street Global Advisors offices in London to discuss what this means for the industry. 10 CONTRIBUTE AUTUMN/WINTER 2014

2 The End of Pensions? O n the face of it, the Budget changes seemed initially straightforward: DC scheme members are simply no longer required to purchase an annuity at retirement. Yet the consequences are surprisingly complex for both scheme members and the providers of pensions. Gary Smith at Capita Employee Benefits explained at the roundtable event: The Budget proposals have made things more complicated not less, so it s going to be beholden on all of us to try and do more to make sure that people don t make ill-informed decisions. D Will the term pension become obsolete? Members now have three choices available at retirement: take their pot as cash, use it to purchase an annuity or opt for income drawdown. Or they could divide up the pot into either two or all three of the available options. Since the announcement of the changes scheme providers have been working hard to communicate these changes to their members who are on the brink of retirement. Jonathan Parker at Barclays said at the roundtable: It s important to ensure people don t lock into annuities and are then not able to change their mind. Paul Black at LCP added: It can t be emphasised enough how important it is to keep communicating these changes to members. Schemes need to make sure members are aware of their options at retirement. While it s obviously vital to ensure that those who are about to retire understand what these changes mean for them, the bigger challenge is what these changes mean for future generations who will retire in two to three decades. A pension was about retirement income. It s not that anymore. The phrase that is out there is later life savings vehicle. Damian Stancombe Barnett Waddingham To understand the scale of the challenge it s necessary to look beneath the bonnet of the standard DC scheme. Rather than making investment choices, most scheme members opt for the default fund, which aims to provide the best outcome for the greatest number of scheme members. During the earlier years of a member s working life, the contributions paid into this default fund aim to grow the size of the pot, typically by principally investing in growth assets such as equities. But while equities are good at generating return, they are notoriously volatile. To protect the value of the pot, leading up to retirement, these assets would be switched to more stable fixed income assets. There were two benefits to switching across to gilts and bonds. Firstly, this could help to protect the value of the pension pot; and secondly, fixed income assets of a specific duration could be used to more accurately mirror the pricing of annuities, helping a member preserve annuity purchasing power, and secure the best possible deal on retirement. Scrapping the requirement for the scheme member to buy an annuity undermines the rationale for switching the pension pot into long duration fixed income assets. If the member is no longer required to buy an annuity, why should they have their assets switched into ones that mimic annuity pricing? Some think that these changes will be so radical for future generations that the term pension is effectively obsolete. Damian Stancombe at Barnett Waddingham said: A Pension was about retirement income. It s not that anymore. The phrase that is out there is later life savings vehicle. Stephen Budge at KPMG agreed: It s a message we have been trying to get through the word pension has never been popular. So let s call it retirement savings. To understand why pensions may no longer be an appropriate phrase, let s scroll forward to the future. Article continues CONTRIBUTE AUTUMN/WINTER

3 Stancombe said: Our view is that until the age of 50 the default fund makes sense for everybody, as long as it has an infl ation plus target. It s only after the age of 50 that people need to be more engaged to start to shape their retirement. Parker agreed: We ve been talking to a client about designing a scheme whereby everyone is defaulted into a solution up to a certain age and at that particular age you sit down with someone and talk through their three investment options and that shapes the next 15 years of their investment strategy. The future Protecting against volatility is not just for the savings phase, it s even more important for the retirement phase. It s all about wealth preservation. Stephen Budge KPMG The generations who retire in 20 or 30 years will have accumulated most of their pension savings in DC rather than have a mix of DB and DC pensions. That means they will have a larger pot of accessible money than today s retirees, which will give them more options at retirement. The abolition of the requirement to buy an annuity means that scheme members could have control of this pot of money until they die. That pot of money will have to provide them with an income in retirement but it will be more akin to standard savings vehicles than a traditional pension. This new concept of a savings pot that scheme members accumulate during their working years and follows them into retirement raises some interesting investment challenges for the providers of default funds. Most of those challenges will come as scheme members move towards retirement. Martyn James of Mercer said: During the earlier years of a member s working life, the goal remains the same as today: you need to save. The challenges for the provider of the default fund also remains the same: they must invest the member s contributions in a way that will generate as much return as possible without taking on too much risk. SSGA s Nigel Aston noted: The fact that we have given people freedom of choice hasn t suddenly created a population of people who are experienced, engaged or even interested in these issues. You still need some sort of default to ensure that workplace saver s money is invested effectively and effi ciently. With three options available at retirement cash, income drawdown and annuity it could be more challenging for pension schemes to provide a simple default fund at retirement as it will be diffi cult to predict which option will be the most popular among which group of pensioners. It should be borne in mind, however, that plans in countries such as the US and Australia, where similar freedom has been available for some time, have largely adopted such a single default approach. It will be interesting to see if the UK follows suit. There are different challenges involved with each of those three options. The cash option may be the most straightforward, although it s not currently clear from an investment perspective how much of the pot should actually be held in cash. While members will no longer be compelled to buy an annuity, this is likely to remain an attractive option for some, but these products need to evolve. James said: Members may want to use a part of their pot to buy an annuity but will also have the option to withdraw their cash. They want the security of income but also to have the fl exibility and liquidity. Gareth Doyle of Hymans Robertson added further insights via correspondence: We do still expect some members will want the certainty of a guaranteed income either at retirement or at some point after retirement. We therefore believe that some members will still buy an annuity. However, we do expect to see more tactical purchasing of annuities or people buying annuities at older ages. Designing income drawdown products is more complex. Budge said: It s one thing to just withdraw some cash from the pot but it s a whole different ball game to facilitate regular income to a member, generated from an investment. SSGA s Helen Copinger-Symes added: We have to avoid making it overcomplicated or create too much choice because that doesn t drive good decisions. We need to create appropriate options rather than trying to filter and channel. Ensuring drawdown works properly will not only be about having an investment strategy in place that generates an income, but also protecting the capital value of the pot. Budge said: Protecting against volatility is not just for the savings phase, it s even more important for the retirement phase. It s all about wealth preservation. 12 CONTRIBUTE AUTUMN/WINTER 2014

4 The End of Pensions? D Black added: Post-retirement, people s capacity for risk goes down because before retirement people can at least decide to carry on working. Once you re into retirement, that option is no longer there. But wealth preservation might well not be enough. James said: While we expect there to be products developed which will provide some protection from investment risk, the big risk is the longevity risk which these products cannot protect against. The fact that we have given people freedom of choice hasn t suddenly created a population of people who are experienced, engaged or even interested in these issues. You still need some sort of default whether that is still an annuity or is simply annuity-like in its behaviour. Markets going down by 20% or 30% are a huge risk in retirement but for a person living five years extra it is a much bigger risk, he added. While dropping the requirement to purchase an annuity at retirement gives members more choice over how they should spend their pension pot, the changes also bring considerable challenges. Both scheme members and pension providers will have to adapt to this much more complex environment. Charlotte Moore is a freelance journalist who writes for a number of different investment and pension publications including Portfolio Institutional, IPE, Pensions Insight, Financial News and Pensions Age. Nigel Aston, SSGA Our thanks to: Paul Black Investment Partner, Lane Clark & Peacock Stephen Budge Head of DC Investment at KPMG Pensions & Investment Advisory The Budget proposals have made things more complicated not less, so it s going to be beholden on all of us to try and do more to make sure that people don t make ill-informed decisions. Gary Smith, Capita Employee Benefits Gareth Doyle DC Investment Research, Hymans Robertson Martyn James DC & Savings Team Leader, Mercer Charlotte Moore Moderator Jon Parker Head of Investment Proposition, Corporate & Employer Solutions, Barclays Gary Smith Head of DC Consulting, Capita Employee Benefits Damian Stancombe Head of Workplace Health & Wealth, Barnett Waddingham for attending and contributing to our first SSGA Consultants Roundtable. For a full transcript of the roundtable discussion, go to ssga.com/ukdc CONTRIBUTE AUTUMN/WINTER

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