With the inexorable rise of defined contribution (DC) and the progressive shift in focus by policymakers towards DC decumulation, this edition of Pensions Watch examines the PPI's recent research findings into DC decumulation policies across the globe and asks what lessons the UK can learn from the eight pension systems covered.1 Spoiler alert - it isn't a simple copy and paste.
Decumulation decision making is difficult
Defined contribution (DC) decumulation has been described, by Nobel prize winning economist Bill Sharpe as, "the nastiest, hardest problem in finance". And for good reason. Striking a balance between meeting current and largely unknown future needs, not least given the vagaries of longevity and health longevity, is indeed a knotty problem. Moreover, given worries about future financial security, health, later life care and leaving an adequate bequest, moving from a deep-seated lifetime-of saving mindset to a spending frame, by drawing on an exhaustible, nonreplenishing pot of money, demands a fundamental psychological shift of mindset. Consequently, when given a choice of how to utilise their DC pension pots, many retirees are reluctant to draw down their pension assets - many simply withdraw the income generated - thereby compromising their retirement living standards, often dramatically so.2 Of course, at the other end of the spectrum, there are those who operate a myopic approach to retirement spending, resulting in them outliving their retirement savings, sometimes very prematurely.3
So, whether outliving retirement savings or living in penury in fear of doing so, the risk of individuals sleepwalking into a suboptimal retirement is ever-present. Quite the problem then and unquestionably a growing policy issue.4
The UK experience
In the UK, prior to the 2015 freedom and choice reforms, most DC savers were required to annuitise their DC pots at retirement to provide a lifetime income. This accorded with the fundamental mantra of the OECD and the Mercer CFA Global Pensions Index,5 that the primary objective of any pension system is to ultimately generate a secure and sustainable income stream in retirement.6 However, post-freedom and choice, despite the ever-greater dependence on DC provision in retirement, the multitude of largely unquantifiable investment, economic and demographic risks which need to be managed and the difficult choices that need to be made, the decision-making process continues to be largely unsupported by the provision of accessible frames of reference, guidance and low-cost advice. This, coupled with the almost total absence of financial education, especially from an early age, means that even the simplest of calculations or concepts are largely unfathomable to most people.
Consequently, most people simply don't know what's feasible and realistic at and in retirement.7 Moreover, this enormous decision-making burden, which weighs heavily on the shoulders of a largely ill-equipped, disengaged and rapidly ageing population, with a deeply entrenched preservation mindset, comes at a stage in peoples' lives when financial literacy and cognitive ability often starts to decline. Couple all of this with retirement increasingly being phased, rather than a one-off event with a well-defined destination point, that demands a solution which offers both security and flexibility, and you definitely have "the nastiest, hardest problem in finance" to grapple with and ultimately resolve. The question, of course, is how.
Read previous Pensions Watch articles by clicking on the links below
Pensions Watch 1, Pensions Watch 2, Pensions Watch 3, Pensions Watch 4, Pensions Watch 5, Pensions Watch 6, Pensions Watch 7, Pensions Watch 8, Pensions Watch 9, Pensions Watch 10, Pensions Watch 11, Pensions Watch 12, Pensions Watch 13, Pensions Watch 14, Pensions Watch 15, Pensions Watch 16, Pensions Watch 17, Pensions Watch 18, Pensions Watch 19, Pensions Watch 20, Pensions Watch 21, Pensions Watch 22, Pensions Watch 23, Pensions Watch 24, Pensions Watch 25, Pension Watch 26, Pension Watch 27
1 See: What can the UK learn about other countries' approaches to accessing DC savings? Nick Hurman, Pensions Policy Institute. November 2023. Columbia Threadneedle Investments is one of five sponsors to have proudly sponsored and participated in the
compilation of this report.
2 The US, Australia and New Zealand all have systems that do not require retirees to annuitise their DC assets into a lifetime income. As the PPI report notes, "The evidence from these countries is that rather than drawing down their assets in retirement and relying on a State Pension underpin, more retirees are reluctant to draw down the majority of their capital. In the US, on average and across all wealth levels, most current retirees still had 80% of their pre-retirement savings after almost two decades of retirement. Although this figure is likely to be weighted to those with the most wealth, even for those in the lowest wealth group, more than half had 50% or more of their assets remaining after 17-to-18 years of retirement. In Australia, maintenance or growth of assets occurs despite policy settings designed to stimulate drawing of assets. As a result, most leave the majority of the wealth they had at retirement as a bequest. Retirees tend to consume only the income from their assets and not the assets themselves. In New Zealand, there is a tendency for retirees to treat KiwiSaver pots as a nest egg, leaving them with their provider or withdrawn and put into a savings vehicle, as they are not confident to use their accumulated assets to fund their retirement." See: PPI report p.10.
3 In the UK, this is evidenced by full and partial cash withdrawals from DC pension pots continuing to escalate beyond pre-pandemic levels, the Treasury's income tax-take from cash withdrawals far exceeding expectations and FCA retirement income data recording a majority of withdrawals exceeding 8% of capital.
4 One succinct way to think about decumulation is as two tightly-interlinked problems: an investment one - how should I invest my money? - and a planning one - how much should I take from my pot and what pattern of income do I want or expect in the future? In the pre-freedom and choice era, the planning decision was determined in advance and so the investment problem became relatively easy - basically it was only an accumulation problem.
5 See: OECD (2022) Recommendations of the council for the good design of defined contribution pension plans. Also see: Mercer (2022), Mercer CFA Institute Global Pension Index, accessed at https://www.mercer.com/assets/global/en/shared-assets/global/
6 Dispensing with compulsory annuitisation post-freedom and choice has resulted in the UK being continually marked down in the Mercer CFA Global Pensions Index's annual assessment of global pension systems.
7 77% of UK DC savers do not know how much money they need in retirement to support their desired lifestyle. See: https://www.retirementlivingstandards.org.uk/details