The National Employment Savings Trust (NEST) has revealed plans to deliver in-scheme drawdown and deferred annuities in response to the ‘freedom and choice' reforms.
In its Future of Retirement report, published this weekend, the provider laid out a blueprint for its retirement income strategy.
The report, compiled after an extensive consultation, says NEST's future strategy will be built around three building blocks: income drawdown, a cash lump sum fund, and later life protected income.
The first fund will be intended to provide a steady income and protect against inflation while still offering flexibility.
The cash fund would be highly liquid and give members the ability to make ad hoc withdrawals to meet any unexpected needs.
The last fund would need to protect members from running out of money, and NEST said it be based on deferred annuities bought gradually, or risk pooling within cohorts.
NEST chief investment officer Mark Fawcett said: "Since the pension freedoms were announced the challenge to industry has been to help savers achieve a sustainable retirement income without removing freedom and flexibility.
"We believe this is possible but it requires innovation. Many of NEST's members are the first generation of savers who'll rely almost entirely on their DC [defined contribution] pots and their state pension in retirement. This makes it absolutely critical that we get this right for them."
NEST said it was well aware of the challenges involved. The key risks that need to be managed in the first two phases were the sequencing of investment and inflation risk.
To protect against longevity risk, the corporation laid out two options. It said members could progressively purchase deferred annuities by slicing off a regular premium from their monthly income payments distributed by the drawdown arrangement.
Alternatively, NEST proposed a model of collective DC that would pool risks within cohorts, but would not incorporate any intergenerational risk sharing.
It said any all proposals would be assessed for cost and risk management and it would be several years before these proposals were put in place.
However, Hargreaves Lansdown head of research Tom McPhail (pictured above) said it would be difficult to create a system of deferred annuities in the UK. "To date, investors have shown no appetite for buying deferred annuities, so packaging this up in a way which is attractive to investors could be challenging and complicated."
McPhail added while NEST had not yet been able to put a price on the deferred annuities, the projected package of measures could deliver an income of 4% a year. This income would be inflation linked up to age 85.
"For comparison, a level annuity would typically pay around 6% at current rates and a drawdown plan purely distributing the income from the underlying investments would pay around 3.5%," continued McPhail.
To see Ros Altmann's response to the consultation before she became pensions minister, click here.
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