The pathway to retirement income

Following the pension reforms introduced in 2015, the traditional phases of the retirement income journey are becoming more intertwined. An increasing number of defined contribution (DC) members are taking advantage of the freedom to access their pensions from the age of 55, and in many cases are still continuing to work and contribute to their savings. Likewise, increased longevity and greater flexibility in working patterns mean many people are working beyond the age at which they would normally have been expected to retire and start drawing their pension. 

In this context, retirement savings are becoming increasingly institutionalised, as providers allow members to draw down an income while remaining in workplace schemes. Over the next decade, the total pension assets held by over-55s still in work are expected to more than double from £263bn to £556bn, with growth especially marked in workplace pensions¹. However, how members use their DC pots will vary greatly depending on individual financial circumstances and lifestyle choices. It will therefore be critical for schemes to ensure investment options are designed to take account of retirees' income requirements.

The Financial Conduct Authority has proposed that drawdown providers offer four default retirement pathways for individuals to choose from, based on their ambitions and requirements, which would include withdrawing all their money in a relatively short timeframe, or using the money as the basis for a lifetime income. Since DC pensions will become the key source of income for the majority of retirees over the coming years, it is natural that providers and asset managers have focused on developing default solutions that provide a long-term income. Such portfolios will need to remain liquid and flexible early in retirement, while seeking to deliver a reliable income at later stages, taking into account longevity and potentially higher medical costs. Multi-asset income funds, which take a global approach to investing across a variety of asset classes, could form part of a solution, offering diversification benefits that can be relatively straightforward for the end-investor to understand. Annuities could have their place in such a pathway too. Buying one when a retiree reaches 80, for example, could help provide a secure income, and avoid the need for difficult financial decisions to be taken later on.

The consideration of these default retirement pathways will be critical for the design of default strategies in the accumulation phase. There is a widely accepted view that a 25% allocation to cash is sensible at retirement, as many members will want to take this portion tax-free. However, the asset allocation in the rest of the portfolio will need to evolve to reflect the nature of default pathways for retirement and to avoid significant reinvestment risk. Ultimately, if retirement income pathways are incorporated into default design at an early stage, the final investment outcome should be better for the member. Not all defaults are created equal. 

Joo Hee Lee, multi-asset solutions manager, Newton Investment Management

1 Broadridge, UK Defined Contribution and Retirement Income, 2018

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