In the March 2014 Budget George Osborne announced a fundamental reform to the way people access their pensions by abolishing the effective requirement to buy an annuity. The 2014 Pensions Bill also heralds change as it sets out additional options for occupational pensions to share risks.
These changes provide a different regulatory framework for DC pension schemes – in particular, they allow for the transfer of risk between providers, advisers and individuals.
Nest’s current consultation, The Future of Retirement, considers how retirement experience is changing, and the possible implications for DC scheme design.
People’s attitudes towards retirement are changing. We believe that this is due to a combination of factors, including:
The marked increase in life expectancy resulting in longer retirements, combined with the increased likelihood of needing to fund care during that period,
the current low interest rate environment offering low returns,
a growing realisation that the adequacy of retirement provision from the state is likely to reduce,
a decline in the availability of final salary pensions,
a move towards more flexible working practices,
the increased number of single person households,
the increase in the state pension age, and
a variety of other cultural and demographic changes.
People are generally retiring later. Retirement has also become less of a definite line in the sand, having evolved into a process in which people’s work patterns vary, and they gradually work less.
Research has shown that many people approaching retirement are worried about their money running out. This concern incorporates volatility, inflation and longevity risks.
When individuals buy an annuity, the risk of running out of money is taken by the provider. The provider will guarantee that the individual receives an income that is stable – or index-linked, if selected – for the rest of his life. Of course, the downside of this approach is that the individual may have such a small pot for his retirement that his income is small. However, there is certainty about what the income will be.
After April 2015, the individual can do what he likes with his retirement pot. The risk of running out of money lies in his own hands. Unless and until, that is, the individual asks an adviser to sort out his retirement finances, at which point the risk is handed to the adviser.
The March 2014 Budget announcement shifted risk from the provider to the individual and – when used – to the adviser.
The 2014 Pensions Bill is to “make provision about pension schemes, including provision designed to encourage arrangements that offer people different levels of certainty in retirement or that involve different ways of sharing or pooling risk and provision designed to give people greater flexibility in accessing benefits”. For example, this may result in defined contribution schemes – where the risk of running out of money in retirement sits with the individual – including longevity insurance in the scheme, so that some of that risk is managed by the provider.
Individuals’ goals and needs in retirement are significantly different now than when the current generation of products were developed. In addition, the changes in the regulatory framework mean that the amount of risk placed with an individual will change, which should have a big impact on the products and advice that these individuals need. Change is clearly needed, and Nest’s consultation is timely as part of a drive to challenge existing thinking and to strive for structures which better meet individuals’ needs.