Panellists discuss the proposed amendments to default retirement age and state pension age, and look at how DC schemes will deal with these changes
It was announced that the default retirement age (DRA) is to be phased out. How will this affect how DC schemes operate?
Will Aitkin: This has major implications for DC schemes. The change may shift some DC risks back to employers. Who ‘owns’ the risk that an employee can’t afford to retire? At present, it is probably the employee, but if the default retirement age goes, the employer is now exposed to that risk. In some organisations, the removal may have limited impact and as such minor changes might be required to their scheme. In other scenarios, the removal may dramatically alter the make-up of the workforce over the next decade, and will have similar implications for the pension scheme. Pension schemes may once again become workforce management tools, and those organisations who fear having an elderly workforce may need to start monitoring potential pension levels and ultimately pay higher pension contributions to avoid this outcome.
Most schemes operate a default retirement age of 65, and many operate lifestyles directed towards that age. That may no longer be an effective solution for large proportions of members. Given coming auto-enrolment, a default retirement age seems unavoidable, so getting members to select a suitable retirement age for themselves will require a ramping up of member engagement.
We see ‘DC journey planning’ as the solution. If we can get members to set a target retirement income (or if we set a default income target for them to start with), they can start making regular decisions to help them hit that target, using the main levers available to them – retirement age, contribution rate and investments.
Steve Charlton: The announcement that the default retirement age is to be phased out should have less impact on DC schemes than other forms of retirement benefits. Typically a scheme retirement date would be linked with the employers default retirement age; this in turn has traditionally been linked with State Pension Age.
In principle the removal of the default retirement age would not cause operational difficulties for most DC schemes. However it might leave members with a decision to make on when they want to retire, particularly if traditional lifestyle switching remains in vogue and while many communication practices fail to reflect member requirements. While the introduction of auto-enrolment will remove the need for members to make a decision about joining the scheme, it might increase the incidence of disconnects between the age that lifestyle investment processes work to and when the member intends to retire.
Dave Hodges: The emergency budget has confirmed that the default retirement age will be quickly phased out following consultation. Many schemes have operated on this basis for some time and with most contract-based arrangements, this change will not make too much difference. Some occupational schemes and their sponsoring employers are more restrictive around retirement ages. Though welcomed by members, these schemes will have to change their approaches, and possibly their rules to accommodate these changes following the proposed consultation.
On a practical level there will be an increased necessity for trustees and scheme providers to wholly increase their efforts on engaging with members over their long term savings and to understand and facilitate their requirements for a more flexible drawdown of the funds accumulated.
Jamie Jenkins: If the default retirement age is removed, employers will need to ‘objectively justify’ the enforced retirement of staff. At present, they must do so only for over 65s. Employers must offer similar benefits, including DC schemes, to workers doing comparatively similar work, which means that older workers must be offered membership of the DC scheme if younger workers doing a similar job are.
Most people still want to retire, either partially or fully at some point in their lives. Employers should therefore look on their DC scheme as the means by which employees can afford to retire at a reasonable age and plan with the employee to make sufficient contributions to allow them to meet their aims.
Martin Palmer: I don’t see the phasing out of the DRA necessarily having a huge impact on today’s generation of DC schemes, as it is likely they will be set up with a default SRA with members being able to select an alternative date if they wish. However, it will be essential for members to regularly review their target age, funding levels and investment choices to make sure that they are in a good position when they do choose to retire. For example, if members who have opted for lifestyling don’t target it to a realistic retirement age, they may miss out on the potential growth from more high to medium risk investments if they transfer to lower risk funds too early.
Away from DC, I can potentially see some issues for group risk products because the cost of providing any protection benefits for someone at 70 or beyond would be a lot higher than someone who is retiring at 65. As a result, employers could be tempted to scrap the cover before it becomes too expensive.
Have you seen any major shifts in how people enter the retirement phase (i.e. the move to phased retirement) in recent years?
Will Aitkin: Not markedly. There is anecdotal evidence that suggests some individuals are slowly shifting into retirement rather than switching from employment to retirement overnight, but it appears that this is still very much at the margins. If anything, income drawdown has become perhaps less popular in recent years than it was a decade ago. Against a backdrop of economic uncertainty, it is not surprising that individuals cannot afford to slowly withdraw from the workforce and are seeking the certain income provided by an annuity.
Steve Charlton: The majority of members continue to retire at landmark birthdays (age 60 or 65 being most popular) and they tend to adopt an all or nothing approach to retirement as few DC members have accumulated sufficient savings to be able to afford any other approach.
Intuitively you would expect this to change as the size and maturity of the DC-reliant population increases, which raises the question of how DC investment options might need to adapt to better suit the needs of a population with differing retirement intentions.
Dave Hodges: In recent years the major shifts have been restricted to those who have accumulated sufficiently large pots to move into phased and drawdown vehicles. Thus far this has, in the main, been the preserve of those with DC pots in excess of £100,000 who also have access to financial advice. For the vast majority of DC members, annuitisation has been the only realistic option.
However times are changing with better awareness of alternative annuity options. Undoubtedly going forwards DC funds, as the mainstream pension vehicle, will be larger and working longer will become a necessity for a much larger proportion of the population. These factors will drive the need for better long term savings planning and phased and partial retirement will be far more commonplace.
Jamie Jenkins: Since A-Day, a number of people have used the facility to draw their tax-free cash entitlement in isolation of the taxable income. This is particularly evident among SIPP customers. However, where people do elect a pension, it tends to be the maximum available, suggesting it is their main source of income and that they need it to live on. In the earlier part of this year, we also saw a number of people taking benefits before the minimum age was moved from 50 to 55. For some, this will have been out of necessity, but for others, perhaps in fear the tax-free cash element may be under threat from future government.
Martin Palmer: For a number of years we have been working with the Life Academy to help pension scheme members understand the challenges of retirement before they actually get there. We have found this very useful as those challenges don’t stop at finances.
In terms of phased retirement, I’m not sure how many people are actually taking up the opportunity. I think the opposite of deferring is happening – employees take the whole of their retirement pot plus do a part-time job. But that creates another challenge for employers – they will see more requests for part-time working. Are they prepared for that? It is crucial for the government to see the long-term view of the changes they are introducing as well as the additional admin burden these impose on employers.
How well adapted do you think the DC market is to deal with this evolving market? What changes need to be made to ensure it remains fit for purpose?
Will Aitkin: When DC is compared to DB, the lack of promises and guarantees offered by DC mean it is frequently seen as a poor relation. However, this lack of underlying liabilities permits DC to adapt to change relatively quickly. At present DC is generally focused on a single retirement age of 65, and very few members take steps to alter that age to something that might be better suited to their needs - even though a sizeable proportion of the population already has a State Pension Age above 65.
However, evidence from the UK and US suggests that members base retirement plans on having enough to live on – if they don’t have enough to live on, they continue to work until they can afford to retire. We need to shift DC’s focus from ‘fixed retirement age, uncertain retirement income’ to ‘target retirement income, target retirement age’. Where we can, we’ll be bringing DC in line with people’s real aspirations.
Steve Charlton: While some of the structures have been in place for some time arguably, we would need a range of products or default investment strategies that would reflect a member’s intention at retirement. In other words there will be a need for a lifestyle product that would continue to remain in growth mode beyond a conventional retirement age for those that intend to draw down income or a protection phase that would switch to index linked assets for those buying an escalating annuity.
But, once again, this would require a decision on behalf of members and indeed an appetite among providers to develop such an option when demand has not yet reached a critical size.
Dave Hodges: Clearly there is a heightened need for effective communication strategies in order to engage more members. I am a fan of using auto-enrolment and default investment options in order to get younger people into the savings habit. However once in the scheme, it is essential to work hard at engagement with access to relevant savings options, effective and easy to use modelling tools and access to workplace guidance and advice.
Workplace savings options need to move on from just pensions and into a more holistic financial planning approach to include debt management, short term savings and long term savings all with appropriate tax wrappers. We do need to overcome the twin constraints of member understanding and accessibility in order to meet the needs of an evolving market.
Jamie Jenkins: Corporate SIPPs are now recognised as a mainstream DC option as many employers restructure their pension provision. SIPP offers sophistication for those who want to exercise such options, complemented by simplicity for employees with more straightforward savings and retirement objectives. All of this can be within one pension scheme, ideally with no cross-subsidy in paying for the functionality each employee uses. However, trust-based arrangements have an important part to play and are becoming more sophisticated in their approach, offering features such as blended funds, flexible retirement, and personalised lifestyling. Both of these ‘pension’ vehicles will be ideally placed to work within the forthcoming benefit platforms that will likely shape the way retirement benefits are delivered moving forward.
Martin Palmer: All in all, the DC contracts themselves – especially the modern generation of schemes – will need very few changes. Where I do see a big challenge is in member communication. I’ve already talked about the need for members to regularly review their provision. Employees will need much more support and information. We will need to be able to offer employees easy access to ‘what if’ quotes: ‘What if I take retirement earlier? What if I stop paying contributions; What if I increase payments?’
We need to get people to start saving earlier. There is a danger that the removal of the DRA will give employees false hope that the DRA removal will provide employees with the legal ability to work into their late 60s and 70s. But will they have the health to do so and will they be able to find work? Ironically the removal of the DRA may result in it being difficult for individuals in their late 50s and 60s to find work as some employers may be less keen to take on people that they won’t later be able to retire.
In addition to the changes to default retirement age it was also announced there would be changes to state pension age. How will communication strategies need to evolve to help people get to grips with these issues?
Will Aitkin: As noted above, few people seem to understand that they already have a State Pension Age above 65, and fewer still will understand how much State pension they may yet accrue. Removal of the default retirement age might yet see default retirement ages for schemes settling at the State Pension Age level, and that will require careful communication. DC journey planning will permit members to make sensible decisions about their retirement ages based on their own circumstances.
It is worth noting that member understanding of State pensions is generally very poor – which is not at all surprising given their complexity. Communications that help members understand their company pension in the context of their overall pension wealth will aid members enormously, as would simpler State pensions.
Steve Charlton: Communication will be key and will need to be tailored to individual scheme members and according to the range of solutions offered by each specific DC arrangement. This communication might leave out any reference to a retirement age at point of enrolment to overcome the current barrier to joining but the issue will still need to be picked up in due course such that members have the opportunity to match their investment strategy with their retirement intentions.
Current communication is generally compliance driven and narrow, rarely focusing on planning and outcomes. Schemes should undertake member profiling and generate targeted communication relevant to the individual. With the changes to state pension age and general benefit inadequacy, the message to individuals needs to be clear: either save more, work longer or face a significantly reduced standard of living in retirement.
Dave Hodges: In the budget the government has stated its desire to accelerate the increases to state retirement ages and it is essential that long term savings plans take this into account. Good modelling tools already accommodate state pension forecasts, preserved benefits as well as other savings. Modelling tools will need to evolve further to take into account phased withdrawal options.
Increased diversity in career paths, changes to family circumstances, longer mortgage terms and longer working lives are all factors pointing to the need for carefully formed communication strategies that are targeted at segments of the scheme membership. Access to workplace information, guidance and advice will be increasingly important as the state retirement goalposts move. Increased flexibility in workplace retirement practices brings a greater need for engagement.
Jamie Jenkins: A more holistic approach to financial planning will be required as retirement in the traditional sense is a thing of the past. The demographic wave that will result in an aging population will breed a culture where work is adapted to fit various life stages. For example, second careers are becoming increasingly commonplace as “60 becomes the new 40”. We need to help people recognise that the risk of investing and saving for a pension has been transferred from employer to employee. Similarly, expectations for state provision need to be managed and the idea that the state provides a safety net rather than a panacea for retirement is a message that needs to be clearly stated.
At the other end of the age spectrum, Generation Y will be more transient, having a transactional approach to the relationship with their employer. They, more than anyone, will need to understand the inadequacies of simply relying on state provision, and they’ll expect to learn through social media, amongst other emerging technologies.
Martin Palmer: Communication and member engagement will become even more crucial as we need to ensure that members are fully informed as to what level of pension they can expect when they retire. Members need to fully understand how altering their planned retirement date could significantly affect their expected level of income in retirement.
Will Aitkin, DC consultant, Towers WatsonWill Aitkin is a specialist DC consultant. He has over 17 years experience in advising on and establishing new DC schemes for all sizes of employer, from FTSE 100 to start-ups.
Steve Charlton, Principal, MercerCharlton joined Mercer in 2008 to help further build on the depth of knowledge and experience in its DC services team. He has nearly 25 years experience in the pensions industry with the last 15 years spent advising clients on a variety of issues from DB to DC transitions to member engagement and benefit adequacy.
Dave Hodges, Client relations director, Zurich Corporate Pensions, UK LifeDave Hodges joined the Zurich group in 1984 and became the client relations director for Zurich Corporate Pensions in 2006. He is responsible for managing relationships with existing clients and transitioning new clients into Zurich. Hodges is FPC (1, 2 & 3) and AFC (Pensions G60) qualified.
Jamie Jenkins, Head of corporate strategy, and propositions Standard LifeJamie Jenkins has worked in financial services for over 20 years, most of which he has spent in the corporate pensions area. He currently heads up the strategy and propositions team for pensions, savings and flexible benefits. He has worked on the development of Standard Life’s employee wealth proposition.
Martin Palmer, Head of corporate pensions marketing, Friends ProvidentMartin Palmer joined Friends Provident in 1987 and has worked in a broad variety of roles in the company. He is now responsible for the development and communication of products, services and technology to meet the needs of Friends Provident’s corporate customers in the UK.