In our third blog following the publication of our recent white paper “What can the UK do to ensure future retirement adequacy?”, we focus on making better retirement choices – and look at why DC pension savers need support, the challenges they face making important decisions and consider the potential for Collective Defined Contribution as a future solution.
The traditional pension landscape has shifted dramatically, moving away from defined benefit (DB) schemes as the primary retirement solution. This transition to defined contribution (DC) pension savings, and the introduction of pension freedoms in 2015, places a greater emphasis on member decision-making at retirement, particularly given the array of options available.
Retirement has changed a lot and means different things to different people. Defined benefit (DB) pensions are no longer the driving retirement solution.
Without a fixed pension to depend on, individuals are having to make complex decisions on how best to use the DC funds they have worked hard to save up.
Quite often, there is more than one goal or objective. It’s not just about income planning, it’s about tax, inheritance, mortgage and debts, meeting needs now and in later retirement.
There’s a lot at stake and so the ability for people to make informed decisions is crucial, especially as these decisions are often irreversible and can impact an individual throughout their retirement.
Here, and in our white paper, we refer to people making informed decisions. These two words are significant – firstly, it’s about people making a decision, but secondly, and importantly, it’s about being informed.
We believe this can be achieved through education, guidance and advice:
Education helps people to grasp the basic information needed to navigate their options, guidance provides a deeper understanding based on personal circumstances and advice can give a personal recommendation and/or address more complex needs and objectives, such as tax planning and inheritance.
Understanding all of the options relative to the individual is crucial. So it’s not just about explaining what an annuity is, what drawdown is etc, it’s about what does that mean for the individual. Are there specific options in their workplace DC pension that they should know about? What type of an annuity might be suitable and give the best value? How and where can they access drawdown? All of these questions and more should be answered through the education, guidance and advice process.
It's also worth remembering that a combination of solutions might work best for somebody, and it’s more likely that an individual will understand that if they’ve received appropriate guidance or advice.
Finding a suitable adviser by oneself can be a challenge, with variations in fees, services offered and access to different products. Having a scheme-specific adviser who is familiar with the DC pension plan can help to make guidance and advice accessible to more people.
That’s why we advocate for schemes to offer tailored educational resources and access to professional guidance and/or advice to ensure individuals are well-equipped to make decisions that best suit their retirement goals.
Pension freedoms have provided individuals with flexibility as to how they take their retirement savings, but it has also added complexity. Collective Defined Contribution (CDC) could be a potential solution, offering a middle ground between annuities and drawdown.
CDC is similar to an annuity, in that it provides an income for life. However, the key difference is that the income from CDC is variable and depends on underlying investment performance and demographic experience across all members. The income level isn’t guaranteed, but having greater investment freedom means the income is expected to be greater than that provided by an annuity, and you still don’t have to worry about running out of money or managing your investments, as you do with drawdown. CDC could, therefore, provide a good balance between security and an attractive level of income.
"CDC is a bit like a lifeboat riding the waves of retirement. You're in it with others, sharing the journey and risks together. It's more dynamic than the slow steady ferry of an annuity, but avoids the unpredictable thrill of the jet ski of drawdown
However, CDC as an option for individuals at retirement is not available in the UK (yet). This requires further legislation, and so it may be some time before CDC becomes a reality. However, CDC has had cross-party support, and so we expect its introduction as a retirement option to be a question of when not if. We believe this would be a valuable tool to complement the existing solutions of annuities and drawdown for those retiring in the years to come.
There are key actions that individuals can take to boost their DC pension savings throughout their savings journey, including paying in greater contributions and maximising returns through their investment strategy.
However, all of this could be in vain if informed decisions are not made at retirement.
That’s why it’s critical that education on retirement options starts early and DC pension savers are given the support they need to make the right choices for them, at the right time.
