With the ‘pension freedoms’ soon to come into effect from April 6th, it is more critical than ever for employers and employees alike to assess their ability to cross the ‘retirement finishing line’.
Defined contribution (DC) default funds should be designed with one objective in mind: to help as many people as possible to achieve at least minimum income replacement levels. In the race to retirement-readiness, the type of default design a company chooses will be critical.The pension reforms of 2014’s Budget represent a dramatic change in how and indeed, when, many DC pension plan members will access their pots in retirement. With around 85 percent of plan members relying on a default strategy to get them safely over the retirement finishing line, there is a clear need for companies to assess their employee needs far into the future. Do they have the most appropriate default plan for the post-Budget world? And does it offer them the glide path (the changing mix of assets that a fund invests in as it progresses to an individual’s target retirement date) they need to achieve their financial goals in retirement?
One challenge is that whilst we have seen a number of new product launches off the back of the Budget announcements, we are yet to experience exactly what employees will do in retirement after April. Annuities aren’t dead, there is still a place for them; there is also a place for drawdown (where retirees can keep their pension pot invested and draw an income from it) and, as we have been told, there is a need for more advice. Packaging all these up in the run up to retirement and into retirement is clearly needed, but will not be a simple task. However, whilst we saw a lot of change announced last year the main objective of the accumulation phase should still be the same; i.e. to ensure that as many pension plan members as possible reach the end of their careers with enough savings to generate at least minimum levels of replacement income. Without at least a minimum level of replacement an increasing number of people will not be able to afford to retire. The majority of pension scheme members go into a default fund. And with DC members expected to increase nearly threefold over the next five years, to around 16 million by 2020[1] getting the default option right is more important than ever before.
Britain now has the highest level of pension saving since records began in 1997, with pension membership rising across all age groups, according to new data published today by the Office for National Statistics. The figures underline the success of automatic enrolment – where workers are automatically put into a pension scheme – in rebuilding Britain’s saving culture. To date, the scheme has seen more than five million workers brought into a pension scheme, saving more or saving for the first time. Today’s Annual Survey of Hours and Earnings statistics, which reflect the picture in 2014, show: 59 percent of all workers are active members of a pension scheme – up from 47 percent in 2012; 49 percent of private sector employees are active members of a pension scheme – up from 32 percent in 2012; pension membership has risen across all age groups, the largest increase being in the 22-29 age group, up to 53 percent from 36 percent in 2013; pension membership has increased for every earnings band in the private sector for full-time employees.
Minister for Pensions, Steve Webb, said:“The rise in the proportion of people saving for retirement over the past three years is stunning. Pension saving is now at its highest level since records began. This is due in no small part to the success of automatic enrolment which is changing the culture of pension saving in Britain. Millions more people are now saving into a workplace pension, allowing them to build a decent nest egg to enjoy in their retirement, on top of a reinvigorated new State Pension.” Across the country, all regions saw at least a 10 percentage point increase in pensions membership amongst private sector workers. Membership was highest in the London area (56 percent); The North East saw the largest increase in private pension membership from 33 percent in 2013 up to 51 percent;the South West had the smallest increase of 11 percentage points, up to 46 percent in 2014.
The most commonly used default options have been lifecycle structures however, although a much needed evolution in default design appears to be underway with the growing adoption of target date funds. We believe lifecycle structures are no longer the best solution for maximising the number of members positioned for retirement success. They are often too mechanistic, rigid and confusing to serve the needs of the rapidly growing number of members who will come to depend on DC plans to accumulate the vast majority of their retirement savings. They are also ill-equipped to dynamically manage the changing financial landscape required of a default, for example, capital market and economic dynamics, regulatory changes, changes in longevity and in member behaviour. As such target date funds represent a significant evolution for the accumulation phase, but also offer appropriate flexibility into retirement to help employees access appropriate post-retirement options. With such large numbers of UK savers ending up in the default fund, there is a very real opportunity to a) get the default fund right and b) for industry advisers to support HR Directors and their pension plan members in both the accumulation and decumulation phase. Now is the perfect time to look beyond the short-term implications of the pension reforms to their longer-term financial objectives in retirement. Perhaps we should be paying more attention to the resounding success in the US DC market, which is experiencing increasing popularity in target date funds. Over the coming years, DC investing is likely to represent many peoples’ best chance to maintain their standards of living in retirement. It is therefore vital that companies make the right choices for their DC defaults to enable as many scheme members as possible achieve a suitable income level to be able to retire.
