Nest feathers pensioners’ choices

The strategy, according to chief investment officer Mark Fawcett, is intended to engage and stimulate innovation and product development within the pensions and investment industry, to meet the needs of Nest’s members.

The report was also a response to Nest’s consultation on investing for its members in relation to the newly implemented reforms affecting those in a defined contribution pension scheme.

The consultation found that in the opinion of Nest members, the top three pension products all offered an inflation-protected income, a guaranteed income for life and carrying minimal market risk.

The study stated: “To a certain extent this is a counterintuitive finding for pension providers, as a product fitting this description has been in existence for a long time in the form of an index-linked lifetime annuity.”

The survey not only highlighted an interest in lifelong income, but also revealed an appetite for ad-hoc cash lump sums, and the ability to pass on savings to beneficiaries – particularly in the event of early death.

According to the Nest report: “Features to meet some of these desires have been and are being added to traditional annuity products. However, there is still a general perception that an immediate annuity bought at the start of retirement does not tick enough of consumers’ boxes for it to continue to be the main vehicle for delivering retirement income. Savers perceive them as poor value, inflexible and unfair to those who die early.”

The retirement income blueprint explores three products to cover three phases of later life.

Phase one is applicable to Nest members typically from their mid-to-late 60s to their mid-70s.

It proposes investing around 90 per cent of members’ pension pots into an income drawdown fund which is aimed at delivering a steady income for 20 years, increasing annually to help keep pace with inflation.

Managing risk is paramount to achieving the objectives outlined in the blueprint

As well as paying a monthly income, it has also been suggested that between 1.5 per cent and 2 per cent of the pot would be injected into a separate later-life protected income fund which would be refundable up until age 85.

The other 10 per cent would be allocated to a cash fund, from which savers could take out cash lump sums when they saw fit. Nest said that it would expect cash withdrawn from this fund to be transferred directly into the member’s bank account.

“We believe that describing this as later-life protected income captures the essence of what is intended, managing longevity risk without the familiar jargon,” it said, adding: “Crucially, prior to 75, these allocations are still liquid and can be returned to the member’s estate or his nominated beneficiary.”

In the event that the income drawdown fund outperformed, something Nest considers to be a highly probable event, a “prudent” level of the surplus would be distributed into the cash fund. Members would be free to decide to purchase extra income, keep it saved or spend it straight away.

Phase two is less comprehensive, involving savers aged between 75 and 85, and responds to evidence that a number of people want to remove the risk of outliving their savings. It would also seek the continuation of the income drawdown and the cash fund as before. However, the key difference with this phase is that the money set aside for later-life income would have been locked in. The money would then become part of a mortality pool that started to pay an income for life at age 85.

In phase three, which involves members aged 85 and above, savers would start receiving payouts from the later-life protected income fund. It is designed so that members would not experience a significant difference to their monthly income as they transitioned from phase two to phase three.

The Nest report said: “Any money left over that has not been drawn down in phase one and two would be transferred to the cash lump sum fund for members to use as they wished, or leave to their estate or nominated beneficiary.”

The rationale behind the strategy is based on six guiding principles which Nest outlines in its interim response to its consultation in March.

According to Nest, managing risk is paramount to achieving the objectives outlined in the blueprint. One of these is sequence of returns risk – that of receiving lower or negative returns early in a period when withdrawals are made from the underlying investments.

Any solution should recognise that market downturns in the early years could be devastating to the sustainability of an income drawdown portfolio.

Nest added that whatever approach was used to pay out regular sustainable income would need to be void of systemic risk and have the capacity to invest successfully with large amounts of assets.

In addition, the approach should have no systematic bias to excessively risky or over-valued assets to generate sufficient income.

Mr Fawcett, said: “Since the pension freedoms were announced, the challenge to industry has been to help savers achieve a sustainable retirement income without removing freedom and flexibility.

“We believe this is possible, but it requires innovation. Many of Nest’s members are the first generation of savers who will rely almost entirely on their DC pots and their state pension in retirement. This makes it absolutely critical that we get this right for them.”

Tom McPhail, head of pensions research at Bristol-based Hargreaves Lansdown, said the blueprint would achieve its aim of stimulating product development, but was not without its challenges

“There is no deferred annuity market at present. They need annuity providers to step up and start offering the product,” he said.

Mr McPhail continued: “The blueprint has the right idea and offers investors a flexible solution, but it does not eliminate all the risks that an investor will face. Nest would need to communicate to its members that they were exposed to interest rate risk, and their income could fall or stop temporarily or even permanently”

Patrick Connolly, certified financial planner at Bath-based Chase de Vere, hailed the proposals outlined in the document as sensible and logical. He added: “The challenge for providers will be to adapt. At the moment, pensioners want products that allow them to access the pension freedoms when they want and at times that best suits them.

“I think we are going to see a lot more innovation from providers over the next couple of years. I think the basics are already available in the marketplace, but there are things such as long-term care that need to be catered for.”

Myron Jobson is a features writer of Financial Adviser

Key Points

The strategy outlined in the report is the Nest Trustees’ vision of a retirement income strategy in light of the pension reforms.

Managing risk is paramount to achieving the objectives outlined in the blueprint.

The approach must have no systematic bias to excessively risky or over-valued assets to generate sufficient income.