UK pensions are unsustainable in their present state. They need to be reimagined. The vast majority of today’s pension savers do so through defined contribution (DC) vehicles. However, DC, in its current form, does not provide an adequate income in retirement for most savers. This is not simply because contribution rates are too low. The problem runs deeper than that.
DC is broken because it leads to poor retirement outcomes. It’s broken because individuals do not have the tools and resources to navigate very complex decisions. And it’s broken because it just doesn’t work beyond the point of retirement.
At retirement, individuals have three main options, each of which has significant weaknesses. Some buy annuities, but such annuities often represent poor value. Some fully cash out, often with detrimental tax consequences and without expert support to manage the net proceeds through retirement. Others end up in drawdown, where they are again left to manage on their own, needing to sort through complicated, multi-faceted decisions, often without the specialist help.
What most individuals really need is three things:
So, if DC is broken, how can it be fixed? We contend that there are two essential questions that must be addressed.
The answer to this is very clear: “Yes”. Some of the initiatives progressed by the current and previous governments will have a positive impact. Consolidation leads to scale, which can provide better value for money (VFM) for the member. Revamping the VFM framework so that value assessments look beyond “low cost” and into value creation will also help. There can be further innovation in DC investments, accessing a broader range of asset classes which will enhance returns and diversify risks. And better support, guidance and advice will reduce value leakage for members to limit the consequences of poor decision making by individuals.
Making these changes will improve DC, but we don’t think this is sufficient. Ultimately, DC places too much responsibility on individuals and they are ill-equipped to bear that burden. If Nobel-prize winning economist William Sharpe called the decumulation of retirement savings “the nastiest, hardest problem in finance”, it does not feel right to leave individual members to tackle this on their own. It’s a bit like giving people the parts to assemble their car, rather than building a car for them and providing a service plan.
And the answer, again, is “Yes”. We think this question is not receiving enough attention within the pensions industry, in Government, amongst employers and from employee representatives. So, to act as a catalyst for a deeper, better debate on reimagining pensions, in this white paper we set out four readymade blueprints for alternative pension designs. Each is different, with its own unique risk-sharing and investment profiles. Each seeks to share risks in a way that enables higher returns. Each seeks to improve member outcomes.
The alternative designs are summarised below:
All require a certain scale of membership to be cost-effective, and so either lend themselves to larger employers, or multi-employer schemes or master trusts catering for a number of employers. All also require excellent communication to members, to ensure they understand which elements of their benefit are variable and not guaranteed.
We call on UK employers to acknowledge that DC, as it is today, is broken. We urge them to engage on the two questions we raise in this white paper: can we do DC better, and can we do better than DC? And we encourage them to be open-minded about the art of the possible. These questions fall squarely under the social responsibility that employers have, within the “S” of ESG.
We call on Government to introduce legislative change that improves outcomes in DC and paves the way for the other types of pension design we set out in this white paper. As we run through each design, we call out the key changes to law required for each design to be implementable and we have summarised those changes below. Legislation should be in a form that encourages industry to innovate, in order to avert the looming societal crisis of inadequate retirement provision. And we call upon the whole of the pensions industry to come together to proactively take this debate forward with employers, employee and member representatives, and Government.
Unless we collectively act now, we will fail tomorrow’s retirees. So let us be bold and reimagine pensions.
| Title | File Type | File Size |
|---|---|---|
| Reimagining pensions in the UK | 6.7 MB |
