Should income levels be included in retirement defaults?
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As the government plans to require defined contribution schemes to have a default retirement option for members, some in the pensions industry say these should go beyond pathways or products to include withdrawal levels.
The pensions industry is waiting to see what the requirements in the forthcoming pension schemes bill to offer decumulation services will look like, with pensions minister Emma Reynolds confirming on Tuesday that this would involve a “default”.
At a panel during the Pensions and Lifetime Savings Association’s annual conference on Wednesday, 95% of the audience were in favour of creating hard defaults on retirement.
The response is unsurprising given the issues in this space since the advent of pension freedoms, ranging from withdrawal levels that are unsustainable for pot sizes, to members’ continued reluctance to take financial advice.
Given these issues, Philip Smith, DC director at TPT Retirement Solutions, called for defaults to be wider than pathways, noting that one size “never fits all”.
He noted that the government’s proposals include a default into an ongoing pot but do not cover income.
“We need to go further and provide people with a default level of income as well,” he said.
“It will never suit everybody, there are compromises along the way,” he admitted. “But if we want to provide income for the rest of somebody’s life, that is what we should be aiming for.”
Smith said the default needs to provide an income stream yet be flexible enough to take capital out, while protecting against cognitive decline through a deferred annuity.
“There is a little bit of tension between delivering that flexibility and having a later life annuity,” he admitted, insisting that people must be allowed to change their views.
Having a default retirement income means adjusting it when the pot falls in value, which Smith called a “challenge”.
Referring to TPT’s existing product, running for six to seven years, he said this had a period in 2020 when people saw a reduction in income. “You have to communicate that,” he said.
However, he argued that while income can go down, managed drawdown has produced better inflation adjusted pensions than defined benefit schemes, where increases are typically capped, saying: "It's a bit like [collective DC] for the individual."
For Sam Burden, a client director at trustee firm Zedra Governance, having a default removes the difficulty of having to decide what would be an appropriate retirement age.
“It takes the emphasis away from what is quite a difficult staging point to identify,” he said.
Nonetheless, it is important that the investment strategy aligns with a saver’s objective, he added.
“Having that alignment between your investment strategy and objective is really important. That is the challenging part of having that default. There needs to be some triaging around it, an obvious one is account size,” Burden said, though he acknowledged that “as soon as you start doing that, it’s not a default anymore”.
People need support on how much to draw down, he agreed, and called for more guidance and signposting, saying members would benefit from “a far stronger steer on what’s sustainable”.
For retirement defaults to work for members, pensions ideally need to be in a single place. Smith said technology and digital innovation were key for allowing people to consolidate pots but admitted this was a challenge, while Burden hopes the pensions dashboards could help with this once it becomes interactive.
