Default models have proved successful for accumulation but can the same be said for drawdown?
When an idea works, it is natural to see if it can successfully be applied to something else. So it should come as no surprise that MPs are calling for default decumulation options to emulate the success auto-enrolment has had in the accumulation of retirement savings.
The work and pensions select committee’s recently published final report of its inquiry into pension freedom and choice recommended that every provider offering drawdown must provide a “default decumulation pathway suitable for their core customer group” by April 2019. These would be subject to the same 0.75 per cent charge cap that applies to auto-enrolment schemes.
Given the well-documented problems with non-advised drawdown, many commentators can see where the committee is coming from. There is widespread recognition that in an ideal world everyone would receive personalised advice but factors such as the cost and the potential demand exceeding the supply of advisers means other solutions are needed.
The dynamics of inertia
The success of auto-enrolment owes much to the way it harnesses inertia – people have to make an active decision to opt out, which is more hassle than staying in by doing nothing. It works perfectly when building up retirement savings as the broad aim is to save as much as possible. But at the point of retirement there is no getting away from the need to make active decisions.
JLT Employee Benefits head of DC investment consulting Maria Nazarova-Doyle says: “During the accumulation stage, it is possible to approximate people’s requirements and needs in order to save in a risk-efficient way, but it is almost impossible to second guess how people will want to spend their pots. Simply defaulting people into a specific retirement outcome may not be the correct approach, as we cannot know the best and most tax-efficient option for them.”
Intelligent Pensions head of pathways Andrew Pennie thinks default drawdown models are likely to be very cautious and play to the risk of someone running out of money. “To mitigate this risk, the default will likely control the withdrawal rate and take a cautious investment approach, becoming more like an annuity without the lifetime guarantee,” he says.
“The true value of income drawdown is not avoiding an annuity, it is the flexibility to do things that an annuity cannot do – providing an ongoing solution that can adapt to the individual rather than follow a standard path. While a default drawdown solution might mitigate some of the drawdown risks, we can’t expect it to deliver good outcomes for the majority of users, and for some it will produce very poor outcomes.”
Arc Pensions Law partner Anna Copestake is concerned that a default could further encourage inertia or disengagement by offering an easy way out.
“There a risk that members simply say: ‘oh, the provider will do all that for me’,” she says.
“The practicalities for providers should not be underestimated either. I don’t envy a provider having to compile and monitor a default offering ‘suitable for its core customer group’. That will involve a substantial degree of resources, which will presumably come at a cost. Instead of a compulsory default pathway, is it worth further exploring a compulsory advice or guidance requirement at retirement and during the drawdown pathway?
Passing the costs of this to members may, in itself, affect the attractiveness of drawdown, but at least the end result might do its job.”
No substitute for advice
As many others will agree, Chartered Insurance Institute director of policy and public affairs Matthew Connell says there is no substitute for professional advice.
“Defaults can be designed for ‘typical’ investors but small changes in financial needs can make a default unsuitable. For example, some investments’ charging structures are good value for people making a few, large withdrawals from their drawdown account, but very expensive for people making a lot of smaller, more regular withdrawals,” he says.
Royal London director of policy Steve Webb highlights how advisers would want to get a full picture of an individual before recommending a course of action. “Yet pension providers are being asked to come up with an appropriate default while knowing almost none of this information,” he says.
“The key to good outcomes at retirement is to make sure more people take advice and that savers are encouraged to engage at an earlier stage in the process. For those who do not take advice, we need to ensure that factual guidance is taken at an earlier stage.”
As a starting point for those in drawdown, Beaufort Financial (Reading) IFA Andy Coles likes them to have a two- or three-year cash holding so their income requirements are met even if the market crashes.
He points out that for those going into drawdown and having nothing else around it, a default is always going to be a problem. “It comes back to unadvised drawdown – you are going to create problems. You can’t have a framework that suits everyone,” he says.
Some find merit in what a default model would try to achieve, but stop short of supporting a “true” default where consumers make no decisions at all.
Legal & General Investment Management head of DC Emma Douglas is concerned people are being panicked into thinking they have to make decisions quickly at retirement.
“Wake-up packs sent out to people about to retire are part of the old regime, but in the new world you can take your time. You don’t have to do everything all at once,” she says.
“We’re suggesting a split of assets with four main needs: active years spending, later years spending, a rainy day fund and inheritance. Not everyone will have all four needs but they help people think about what they’ll need to spend and what they leave behind. It’s not really a default but a framework giving them a place to start.”
State Street Global Advisers head of European DC investment strategy Alistair Byrne supports the idea of simplified pathways that start with an exploration of what consumers want to do with their retirement cash – take a regular income, a lump sum or stay invested.
“Where it gets challenging is the secondary decisions – how much income do you need? What should you invest in? That can be wrapped up in a pathway. If you are taking regular income there could be guidance of what might be level to take, albeit with the caveat that the money might run out in the future,” he says.
“The ideal is that everyone would get personalised advice, but the market hasn’t provided that – some people don’t want to pay the fees or advisers don’t want to take on small cases. In the absence of good personal advice, we have to look at other solutions.”
Aon partner Sophia Singleton thinks it is crucial to signpost people to some sort of retirement solution. She says innovative solutions are needed to deliver a sustainable income, longevity protection, flexibility and robust support to consumers through retirement, but says providers are busy dealing with other issues such as their replatforming projects.
Some believe a default for decumulation should be seen as a last resort or temporary solution while retirees take time to consider their options.
Primetime Retirement chief executive Kim Lerche-Thomsen says: “I’m not keen on an automatic default, as that would repeat what happened to lifetime annuities. People have to take a more active approach with decumulation. Whatever happens, the default mustn’t be to the existing provider. That was the experience of lifetime annuities and led George Osborne, in his frustration, to pull the whole mountain down.”
I don’t think a default decumulation pathway can work and non-advised drawdown should be seen as a high-risk product. It’s no surprise that due to the attractiveness of its flexibility, more and more people are opting for drawdown – but many are choosing it without taking advice. Quite frankly, it scares me. You won’t really see the drawbacks of doing this for around five to 10 years. The simple fact is, there is no right default option for everyone. There are so many variants to consider: are you on state benefits? Or are you going to trip over a tax bracket? It has to be tailored for the individual, so getting advice is the best thing to do.
Adviser view: Jonathon Webb, pensions consultant, Montfort
It would be wholly inappropriate to design such default investment strategies, given they are unable to reflect an individual’s attitude to risk, capacity for loss and their unique income requirements. What is more, any default option would almost certainly fail regulatory scrutiny to reiterate how such a recommendation is out of touch with best market practice. Individuals with funds that have a critical mass need to engage with the issues and work alongside advisers who can provide holistic planning.