One year on: how freedom and choice is changing pensions

With the first anniversary of freedom and choice approaching, it is worth reflecting on the behaviour of trustees and members during the past year. A panel at the Pensions Management Institute's (PMI) administration summit on 29 February painted a mixed and complex picture. The underlying impression was that the last 12 months had been busy but the next 12 would be even busier.

The Pensions Advisory Service (TPAS) has been on the frontline of the reforms as it deals with the concerns of people on a daily basis. Head of information and guidance Charlotte Jackson shared a number of statistics. During 2014-15, it supported more than 103,000 people, which increased its workload by 81% compared to the previous year.

Member choices

The average pot size of members contacting TPAS for guidance since freedom and choice came into force was between £45,000 and £48,000. Many of these people had a defined benefit (DB) legacy underpin.

People typically had two defined contribution (DC) pots and some of them had a DB underpin. They were aged 60 on average and men outnumbered women by two to one.

Jackson said: "People's lives are really complicated. Linking one product to another will be key to delivering good member outcomes. The last year has told us how people are different."

From TPAS's view, the year could be divided into two halves with people in the early part of freedom and choice focused on taking cash. This was down to demand that had built up before the flexibilities took hold in April 2015.

But once the demand had run off, people became more reflective and were considering other options apart from taking cash such as having a hybrid solution like a drawdown combined with an annuity.

While members who approached TPAS typically had a mixture of DB and DC pensions to draw on, the reactions from DB trustees versus DC trustees to the freedoms were different.

DC schemes

DC trustees do not have the complex structures of DB schemes but have less money to play with. Speaking at the PMI summit, JTI UK HR director of compensation and benefits Sharon Brittain explained how she helped to design the flexibilities in her company's DC scheme.

Before October 2015 the scheme had a lifestyle strategy with three funds: adventurous (100% active equity), balanced (70% passive equity/30% bonds) and cautious (60% bonds/40% passive equity). These were targeted to an annuity.

It was then decided there should be just one lifestyle fund in the scheme, which came into force after October. "People don't make a choice so we just decided to have the normal lifestyle fund," Brittain said. "We thought about offering three glide paths: cash, drawdown or annuity but again people are not going to make a decision ten to 15 years out of retirement so we decided to head just for drawdown because you can still decide to do something else. It was a good middle ground."

At retirement people can take 25% of their fund tax free but the rest remains invested. On the anniversary of retirement each year, members can take all, some or none of their remaining savings. The drawdown is set up for the short to medium term. "Anyone who wants something more sophisticated needs to go out to the open market and find something. The cost is low. We only charge the investment fees; the administration fee is borne by the company," she added.

The average pot size of a member five years before retirement was £46,741. Brittain said JLT communicated the scheme's new flexibilities to members in a number of ways, including office visits and updating the scheme's website. It also extended face-to-face financial education sessions to people who were single, young or mature, and to their families, for pre-retirement and at retirement.

JLT also overhauled its communication strategy, which involved engaging with staff at three years out or ten years from retirement. Since April 2015, ten members had retired. Two chose annuities, two did drawdown, one person transferred out and the rest took cash.

While it was too early to draw definitive conclusions, Brittain said: "People want to have their cake and eat it. So perhaps flexible drawdown with some type of annuity underpin makes sense."

DB trustees

The flexibilities had inspired lukewarm responses from some DB schemes, according to Law Debenture trustee Rodney Jagelman: "Within DB schemes initially there has been little appetite for shaking up the trust to provide some of these flexibilities within the trust," he said.

"Why is that? There is a whole new level of complication and some [schemes] don't want to be at the front of that. Also there is more of an administrative burden, more explaining to members required, and maybe some potential liabilities falling on trustees and employers if things don't go as well as hoped."

Alongside these difficulties for DB trustees, the tendency for regulations to become more complicated over time could be frustrating. "Trustees are aware they need to make their options available for trustees," added Jagelman. "They are open to criticism in the future if a member comes back and can show with any credibility that they were not informed properly at the time. Presentation of options is not the same as encouraging members to take one option over another."

But how easy is it to set out options without bias? This is a really difficult problem for many trustees that just want to try to help members. Jagelman continued: "At one end we have trustees gettin across the bold outline of the details that might have been communicated in a member's handbook. At the other end of the spectrum trustees could be trying to go into the options that might be good for some people but not others."

DB trustees had to communicate to different people from various walks of life, he added. For example some members may be married and others single, and some will be in good health while others will not. On top of this there were items such as ISAs and inheritance tax which had a bearing on a member's pension flexibilities. Jagelman said: "There is a whole package of issues which effect members' judgement on what is and what is not a good option for them. Trustees are simply not geared up to communicate these to members and I [suspect] they never will be. Somewhere in that spectrum someone needs to pitch that information and advice to members which is helpful."

DB transfers

However, some DB schemes were taking action to allow members access to their pots. Jagelman observed he had seen an uptick in the number of transfer value quotations as well as actual transfers. Schemes had also revised their communications as the direction of travel for DB schemes was being set. "The new environment means that people are going to need to take more responsibility for the security of their income in retirement with advice and research. The future holds more innovation, focus on retirement planning and access to independent advice," he said.

Unfortunately, transfers out of DB were being made tricky by recent market turbulence. The value of the pension pot could end up changing dramatically in the period between a transfer value being quoted to members and when the transfer actually takes place.

"All of this is happening at a time of volatility in the markets and there is agonising over how to deal with transfer values. It may not be as straightforward as it might have been sometimes in the past," Jagelman continued.

Connecting the dots

Whatever happens in any schemes going forward, grasping the psychology and circumstances of people will be critical. "What we need to understand is the new relationship we are all going to have with these people," Jackson said. "There is a tension between people who have not seen themselves as a customer versus having to start doing that with retirement. People will have to shop around. We need to raise levels of awareness and get people to understand concepts beyond straight pensions. These are things like investments and risks that are out of the comfort zone for most of the people we have been talking to."

The pension flexibilities are here to stay, it seems. Whether they force the industry and general public to be more creative about finding solutions for retirement provision remains to be seen.

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