Many of the headlines have given the impression that we're heading for a pensions catastrophe. At a recent conference hosted by Pinsent Masons, the law firm behind Out-Law.com, we asked whether those predictions were fair, or whether reforms are likely to lead to more secure retirements for many.
We wanted to explore the practical things we could all do now to take the UK workforce to a sound and secure retirement future. We also wanted to think about how the potential for further changes to the system could impact on that future.
Given the impact of automatic enrolment on pension saving amongst the lowest earners, it was not surprising that the government's latest figures showed average pension contributions falling. Plans are in place, albeit now delayed, to increase the minimum that automatically enrolled individuals and their employers must contribute to their pensions, from 2% now to 8% by April 2019. But increasing contributions by too much, too quickly, could increase opt-outs among members and lead to protest by employers.
Education is often seen as the answer to the problem of individuals not contributing enough – and so it may be. But how much education, and is it realistic to think that we can improve understanding and change mind-sets to the degree that it will really make a difference?
Perhaps we must accept that helping employees to work things out for themselves is not always viable and that we should be much more directional in the way in which we design workplace pensions and retirement options, at least in the short to medium term. Understanding the requirements of your specific workforce is key: for some with very low incomes, the level of the state pension and interaction with state benefits can mean that contributing more, even if affordable, does not make financial sense.
Driving member outcomes
Automatic enrolment has also lowered the average age of pension scheme members. This new generation of savers, who have grown up with smartphones, apps and internet technology, will expect to be able to manage their financial affairs online.
Easy to use, innovative tools developed by providers which provide online access will help to increase engagement and allow individuals to take more control of their retirement saving. The way we engage with our pension savings should be no different to the way we engage with our money generally, and IT solutions will provide a means by which members can take ownership of their savings.
This time last year trustees and employers were rushing to update their default fund design in preparation for freedom and choice. A year on, what are the longer term pointers on investment defaults? Do some schemes already feel the choices they made before April will need refining?
Crucially, schemes should focus on the changes that are most important for their membership profile. In many schemes the members in their 50s and 60s have small pots which they are likely to take as cash. So if your scheme has three strands to its default fund (targeted at annuity, drawdown and cash) there's probably room to refine the drawdown option over time, because relatively few members will be using it right now.
In the same way, for scheme members in their 20s there is arguably little to be gained by explaining the way the lifestyle strategies work as you get older, because they are years away from making these decisions.
So some reassurance for employers and trustees who are trying to break fund design into manageable steps.
Looking ahead to future developments:
- understanding what your members are targeting is key to designing a default that works well for them. For example, this can be done using tools to assess their target replacement ratios and project future fund values across the membership;
- when setting a new strategy trustees can measure the upside of the strategy against the value at risk for the member. This enables you to get the balance right by increasing the upside while keeping the risk at a proportionate level; and
- there will continue to be innovations in fund design, for example funds that are structured to limit volatility. Trustees and employers should make sure they keep these market changes on their radar.
Charges and governance
Nearly 10 years ago defined benefit (DB) schemes were required to conduct mandatory employer covenant assessments for the first time. In the early days, there was a great deal of variety in what these assessments looked like, while many trustees viewed them as a mere compliance issue - a box to tick.
Over time, the value of the exercise has become clear and the covenant assessment now provides a lot of the context for some of the most important decisions DB trustees have to make. I think there's a lesson there for those involved in DC governance, who are now required to conduct regular value for money (VfM) assessments.
Under the DC model of retirement saving, where the outcome risk falls on the member, isn't it vitally important that someone is responsible for checking that the scheme represents good value? Like the covenant assessment in DB, the VfM assessment in DC will provide a lot of the context for big decisions - in relation to investment, third party supply, communications and many other important governance and administration requirements.
But a word of caution. The DB covenant assessment requirement is nearly a decade old and the regulatory material on how it all works keeps coming through.
I think this means that we can expect VfM to develop over time - but the pensions industry should aim to make sure that it gets it right as early as possible, to make sure that VfM assessments actually deliver something for members rather than just take the form of a box-ticking exercise.
Through workplace schemes, individuals are taken through a passive journey of enrolment, contribution collection, default assessment and, in the run up to retirement, default disinvestment. It's all done for you. However, at retirement, you are transported to the 'wild west', where cash-out, stay invested, annuitise or a combination; when to annuitise; basic asset allocation in drawdown, sustainable withdrawal rate; managing sequencing risk; and inheritance planning are complex concepts and decisions must be faced on your own, with no training.
Much of the 'squeezed middle', with pension pots of between £30,000 and £200,000, cannot afford financial advice.
Some help is at hand from providers that have the tools and science to guide people through these decisions – even taking into account the individual's wider circumstances. However, providers are constrained from offering these tools as to do so risks being found to have provided regulated advice, with all the risk and regulatory costs that comes with it.
The most important change regulators can make right now is to sort out the 'advice gap'. This could take the form of a combination of:
- creating a regulatory 'risk-lite' form of advice, with lower fact find requirements and limited culpability;
- providers deciding to proceed with offering the tools anyway;
- offering such tools through the workplace with 'safe harbour' protection for the employer; and
- advancements in robo-advice and consequent lower costs.
A link somehow needs to be forged between the workplace, where accumulation is managed for the individual; and retirement, the most complicated part of the pensions life cycle, where currently individuals is cut loose to fend for themselves.
The right direction
DC pensions are headed in the right direction. Membership is broadly mandatory, investments are under more scrutiny than ever, governance standards are going up and member-borne charges are coming down. This bodes well for our savings future. But not all is well.
Low earners, those in multiple low-earning employments and the self-employed have not yet felt the benefits of automatic enrolment. To avoid a two-tier society, we need to bring the benefits of retirement saving to a wider audience.
Thinking more broadly, the pensions and savings crisis dwarfs many of the more high-profile problems faced by the UK. We need to strengthen the incentive to save - but we also need to help people to understand that they really can save. Financial education is the solution.
There remains a great deal of work to do before we can be confident of averting a bleak future. There is a role for everyone in this. Industry is in the privileged position of being able to help both savers and the policy makers to head in the right direction.
Tom Barton is a pensions expert at Pinsent Masons, the law firm behind Out-Law.com.