PensionsNov 12 2020

Freedom evolution: Less risk and more support for savers

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Freedom evolution: Less risk and more support for savers

The launch of the pension freedoms in 2015 was a game-changer for savers.

Suddenly, they had a multitude of retirement options to choose from. For some, this felt like a liberation from the constraints of the previous regime, but for many others it made their retirement choices far more complicated than they had ever imagined. 

Freedom is an attractive concept. Intuitively, it seems fair and reasonable to give savers maximum flexibility to decide how to access their hard-earned pension savings. 

In practice, though, these reforms have served to accelerate a pre-existing trend: the transfer of risk from institutions to individuals. As a result, it is now clear that the excitement generated by the freedoms has, in many cases, not been matched by good outcomes for savers.  

To get the most out of the freedoms, they need to evolve, and we have developed proposals for further reform that we believe will facilitate evolution through innovation. 

Prior to the introduction of the freedoms, regulation required most defined contribution savers to purchase an annuity with their accumulated pension savings.

This was intended, in combination with the state pension, to provide them with an income for life.

Key Points

  • Pension freedoms gave people too much choice
  • Most savers do not take an interest in their pensions
  • We should have a system offering savers access to a default system

The liberalised regime introduced in 2015 allows people to access their savings in a variety of ways, namely: by purchasing an annuity; by getting an adjustable income (flexi-access drawdown); by taking cash in chunks (uncrystallised funds pension lump sum); by cashing in the whole pot in one go; or by mixing two or more of these options. 

Evidence suggests that the freedoms have had a dramatic effect on the retirement market.  

Savers have moved away from annuity products and now tend to favour flexi-access drawdown. Prior to the reforms, 90 per cent of pension pots moved into annuities in the decumulation phase.

By June 2018, the Financial Conduct Authority reported that twice as many pots were moving into drawdown than annuities and 2019 figures suggest that the downward trend in annuity purchases has continued. The total value of flexible withdrawals has risen steadily, and now exceeds £35bn. 

Risks that were previously borne by insurance companies are now increasingly borne by individuals.

No regulatory regime can protect people from all the risks inherent in retirement.

However, the freedoms opened up the possibility of people running out of money in later life, of their income being severely affected by market volatility, and of scammers taking advantage of them as they continue to make decisions long into their retirement. Clearly, these are serious risks. We believe that more needs to be done to mitigate them, especially as people come to rely exclusively on DC savings to fund their retirement. 

Supporting savers

One of the major challenges to achieving good outcomes for savers is their low level of engagement with pensions.The most successful pensions policy initiative in a generation, automatic enrolment, relies on the power of inertia. Savers are highly unlikely to transition seamlessly from inert accumulators to active, informed consumers – there needs to be a bridge between these approaches. 

The current retirement market requires individuals to make decisions about complex products that entail different levels of longevity and market risk. Of course, the best-informed and most motivated savers will, at the very least, seek guidance from Pension Wise and, perhaps, regulated financial advice.

However, evidence suggests that there is a significant guidance/advice gap. For example, the Money and Pensions Service estimates there are currently around 75,000 to 100,000 people accessing DC pension pots worth £10,000 or more, without regulated advice or guidance, each year. 

We firmly believe that the pension system should work for those who do not know much about pensions, and do not know where to go to seek help, as well as those who have detailed plans and are confident about the decisions they take.

Evolving pension freedoms

Improving DC savers’ retirement outcomes is at the centre of the Pension and Lifetime Savings Association’s policy thinking. In Hitting the Target, the 2018 report which set out the PLSA’s vision for achieving retirement income adequacy for all, we recommended that the government should reform the freedoms to deliver what we called ‘guided at-retirement decisions’. Earlier this year, we deepened and refined our thinking in this area via a three-month call for evidence on DC decumulation specifically. 

In essence, our proposals would require schemes to signpost savers to a preferred decumulation solution – be it in-house or via a third party. This is in line with what we know about consumer needs. For example, recent research by the Defined Contribution Investment Forum found that 77 per cent of people want their pension provider to offer them a ready-made solution. Our proposals would help to satisfy this demand. 

To operationalise this solution across the pensions market, we believe the government should introduce a new statutory obligation for schemes to support their savers with their decumulation decisions.

This would consist of three key elements – member engagement and communication, products, and governance – all underpinned by minimum standards. In practice, this means the selection and review of the preferred solution would have to meet a set of minimum product and governance standards. Schemes would also be required to deliver appropriate communications to savers in the run-up to and during retirement. This member engagement would also have to meet a set of minimum standards. 

It is important to state here that our proposals do not represent a new form of default that savers would automatically be transferred into at retirement.

This would reverse the freedoms, rather than evolve them. Member consent would be required before any action were to take place and our solution leaves room for people to choose alternative options should they wish to do so. To facilitate this, schemes would provide members with key information and prompts to seek guidance and advice. This would correspond with the new Department for Work and Pensions policy initiative to develop a stronger nudge to pensions guidance. 

On balance, we believe our proposed framework would provide more support to savers in the retirement market than the current regulatory environment.

We expect the requirement for schemes to offer a preferred decumulation solution to stimulate much needed innovation in the retirement market. Crucially, this would benefit from the institutional experience and buying power of trustees and schemes, which would go a long way to delivering sustainable solutions for the mass market.

Lizzy Holliday is head of DC, master trusts and lifetime savings at the Pension and Lifetime Savings Association