Rise of DC poses risks and challenges for future pensioners

The report from the Pensions Policy Institute, published on September 8, explained that increasing reliance on DC pots as opposed to older defined benefit schemes results in “more complex” retirement finances that future pensioners will have to manage, and that these will require more active engagement and will carry more risks.

DB schemes having fallen out of favour for a variety of economic and policy reasons, with many more future pensioners relying on defined contribution savings pots, the report said. 

Alongside this, more people will be working for longer, with an increasing reliance on part-time and flexible working arrangements to smooth the transition to retirement.

Though acknowledging that people’s precise needs in retirement will vary wildly, the PPI report identified as general truths that future pensioners will be more reliant on DC savings, meaning they will need to take more decisions and incur more risk; while fewer people will reach retirement with sufficient savings to maintain their working-life standard of living.

The report identified six archetypes of retirement needs and desires “which can be used to help determine the best retirement income strategies”.

The six archetypes are: providing a secure income throughout retirement, funding retirement prior to the state pension age, providing financial support to relatives, meeting one-off costs (such as home improvements and holidays), saving for bequests, funeral expenses and such; and having a savings account “to use for occasional income to supplement other sources”.

Recognising that “people have varying ideas about what an optimal retirement income looks like,” the report nonetheless said that most archetypes would “benefit from a combination of access to flexible withdrawals and guaranteed income”.

PPI senior policy researcher Dr Mark Baker said: “As people’s working lives have changed, so have their lives in retirement. People will want to access their pension pots in different ways to meet varying needs and wants, using drawdown, annuity purchases or a combination of both. 

“This represents a challenge for guaranteed income providers, as new approaches will have to be sought to meet the demands of a developing and flexible market.”

Action must be taken by the industry to recognise the importance of not only providing the right retirement products to match the needs of their customers, but also offering help to guide and advise themKathryn Fleming, Hymans Robertson

Annuities becoming more important

Changes in work and retirement behaviours are likely to see annuities grow in importance, the report explained; though the precise ways in which this occurs depend on the profile of the individual retiree, and which of the archetypes applies to them.

The PPI used scenario modelling based on three member profiles, and looked at how those who need or desire a guaranteed income in retirement might approach retirement income strategies, as well as how the annuities market is reacting to these emerging needs.

Amongst its general findings, the PPI reported that the timing of an annuity purchase can affect the price, and that those with supplementary incomes may benefit from taking a guaranteed income in mid- or late-retirement.

Those who would benefit from taking an annuity earlier in retirement include individuals who are using all their income to meet their needs, or who are more likely to have variable needs later in retirement, whether because they are renting, are financially dependent on other household members, or have no plans regarding funding care.

Their options are purchasing an escalating annuity early in retirement, or waiting to purchase a level annuity in mid-retirement.

The report also found that the market is responding by increasing the development of products that offer flexible drawdown with embedded guaranteed income elements, while there are further product designs to be found elsewhere in the world - such as variable, deferred, fixed and built-in annuities - that could better meet individual needs were they to be introduced in the UK.

Retirement Line’s director of propositions Mark Ormston said: “There has been a lot of focus on the ‘at retirement’ stage, but people’s circumstances and income needs change throughout retirement.

"I am hopeful that this report will assist with the conversations being had concerning potential pension income frameworks, default journeys and how we best support people throughout the whole of their decumulation journey."

He pointed to Financial Conduct Authority data showing the number of annuities purchased from the age of 75 has doubled in the last five years, calling on providers to “review their offerings to ensure there is not only a functional, but a competitive annuity market delivering value to people looking to annuitise in their 70s and 80s”. 

Members need support

The increasing range of needs means individuals will require much more support to make the optimal decisions, a number of experts have argued.

Standard Life’s managing director for individual retirement solutions Claire Altman said: “As we know, decision making is seldom rational. The report reminds us how true this is when people are making retirement decisions.

"It highlights that - for understandable reasons - people often underestimate their own life expectancy and the possibility of cognitive decline, which leads them to full drawdown rather than incorporating an element of annuitisation, which may well be more appropriate.”

She added that the potential for “bad outcomes” means that “guidance and advice are crucial,” citing research showing that only a fifth of 50-64-year-olds have spoken to a financial adviser about their pension, “highlighting the widely known advice gap”. 

Hymans Robertson partner Kathryn Fleming likewise pointed to the need for support among a list of actions the industry should take in response to the PPI’s findings.

“Firstly, we must re-frame our relationship with annuities and be more creative with the role that these can take in flexible retirement strategies. The industry must seek to leverage the PPI’s retirement archetypes to design products that fit the differing needs and desires of future retirees,” she said.

“Secondly, we should challenge ourselves on the range of investment pathways that currently exist; adding new ones that are combinations of both drawdown and a guaranteed income at a pre-specified age.”

She added that the industry needs to “raise the bar” on how individuals are supported in making retirement decisions, “from the first time they access their savings to a more ongoing basis”.

“Action must be taken by the industry to recognise the importance of not only providing the right retirement products to match the needs of their customers, but also offering help to guide and advise them in how to best use flexibility to achieve better retirement outcomes.” 

Benjamin Mercer is senior reporter at Pensions Expert, FTAdviser's sister publication