The Budget changes have brought major changes to how people access their pension pots. Helen Morrissey examines research that finds major implications for pre-retirement investments too.
- Increased choice of ways to take retirement income means traditional lifestyling is no longer fit for purpose
- Many people will need to remain invested for longer and so it is inappropriate to de-risk in the run up to retirement
- Employees will need to make decumulation decisions well in advance of retirement
The retirement income freedoms announced in the 2014 Budget have had a massive effect on how people access their retirement income. However, what is less discussed is the fact that the choice to take an annuity, income drawdown or cash also has profound implications for how best to accumulate these assets in the first place.
A recent paper published by Standard Life Investments looked at the investment challenges this places on plan sponsors and defined contribution (DC) trustees. The Investment Challenges of Decumulation paper says DC scheme designers should take a ‘whole of life' approach -a far cry from traditional lifestyling strategies prevalent in DC which presume annuity purchase on retirement.
We need age related triggers to get people thinking through their options.
According to the paper an annuity end point meant it was expected investment risk would cease at retirement and so de-risking in the run up to this date was appropriate. Adopting a whole of life approach means the pivot point of retirement is less important as those who go into drawdown - as many are expected to - will need exposure to investment risk after the retirement date to ensure an ongoing income stream. As a result the distinction between pre- and post-retirement investment strategy is not clear cut as it currently is when using lifestyling strategies.
A joined up approach
The paper uses a case study showing the differences in outcome for three investors with retirement dates differing by just one year. The assumption is that at retirement the pension fund is invested 100% in global equities with 6% drawn down as income annually with payments inflation protected over time.
The chart demonstrates the outcome for the saver retiring in 1982 is much better than the one retiring in 1984 whose pension fund runs out after 25 years. This is due to the 1982 member benefiting from strong equity returns in the first two years of drawdown.
However, the 1984 retiree would only miss out on these gains if their investment strategy had de-risked them in the years running up to retirement which is what happens in lifestyling. The following chart shows the outcomes should a whole of life approach be taken and the outcomes are much more similar across the three savers.
Standard Life Investments director Andrew Dickson believes that, while there are challenges, some schemes are starting to take these issues on board.
"We have seen many schemes taking action by offering a series of glidepaths for people depending on whether they wish to take cash, income drawdown or annuity," he says. "I believe we will see the market move forward as we see more demand for income drawdown. However, many schemes haven't taken action for good reason. For instance their membership may be young and so this is not a priority. There are also issues regarding the charge cap and we must not forget that auto-enrolment staging dates are still an issue for many employers."
According to the paper there are clear benefits to having a joined up approach to accumulation and decumulation as retirees avoid the reinvestment and market timing risks that come with lifestyling.
However, such an approach is most successful when the decision of how to decumulate is taken several years prior to retirement. How likely is this to happen given the difficulties faced when engaging people with pensions? Dickson says targeted information programmes will be important in getting people to think about their options early.
"We need triggered information programmes to be developed and come in once the member hits say 45 years of age," he says. "At this point it might just be a case of highlighting the options as decumulation becomes a very individual decision. Someone in their mid-40s might have a property portfolio for instance and so might just want to take their pension. We need age related triggers to get people thinking through their options."
He continues: "I think some providers already have such systems in place and it is something we will see more of. I am an optimist and I do believe that this engagement will build."
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