IFS suggests ‘flex then fix’ with opt-out as retirement default
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A ‘flex then fix’ approach combining drawdown and later annuitisation would work for many, the Institute for Fiscal Studies has said, pointing to the planned introduction of retirement defaults for defined contribution schemes – to be included in this year’s pension schemes bill. However, it said any defaults should be ‘soft’, allowing for opt-outs and alternatives.
The thinktank published two reports on Tuesday, ‘Policies to help people manage defined contribution pension wealth through retirement’ and ‘Individuals’ challenges managing pensions through retirement’, as part of its Pensions Review initiative in partnership with the abrdn Financial Fairness Trust.
Looking at how future defined contribution pensioners should be supported in drawing their retirement income, the IFS finds the status quo risks people exhausting their pots too soon. It therefore calls for reforms to make the system easier to navigate successfully.
The government’s pension schemes bill, set to be introduced to parliament before the summer recess, is expected to include a requirement for DC schemes to offer a default retirement solution. The IFS argues that for many, a solution in which people are able draw down on their pension wealth flexibly earlier in retirement but annuitise at older ages “would work well”, providing a balance between flexibility earlier in retirement and security later in retirement when people are more likely to experience cognitive decline.
However, it qualifies this saying this type of solution would not be right for everyone, pointing to the differences in people’s health and wealth circumstances. Defaults should therefore be ‘soft’, with alternatives provided to make it easy for people to choose other options, the IFS says.
“There will be some for whom a retirement income default will not be right,” said IFS research economist Bee Boileau. “The government and pension providers must ensure that it is straightforward to opt out of whatever new defaults are introduced, and that as far as possible those making these decisions are sufficiently informed and helped."
The thinktank published two reports on Tuesday, ‘Policies to help people manage defined contribution pension wealth through retirement’ and ‘Individuals’ challenges managing pensions through retirement’, as part of its Pensions Review initiative in partnership with the abrdn Financial Fairness Trust.
Looking at how future defined contribution pensioners should be supported in drawing their retirement income, the IFS finds the status quo risks people exhausting their pots too soon. It therefore calls for reforms to make the system easier to navigate successfully.
The government’s pension schemes bill, set to be introduced to parliament before the summer recess, is expected to include a requirement for DC schemes to offer a default retirement solution. The IFS argues that for many, a solution in which people are able draw down on their pension wealth flexibly earlier in retirement but annuitise at older ages “would work well”, providing a balance between flexibility earlier in retirement and security later in retirement when people are more likely to experience cognitive decline.
However, it qualifies this saying this type of solution would not be right for everyone, pointing to the differences in people’s health and wealth circumstances. Defaults should therefore be ‘soft’, with alternatives provided to make it easy for people to choose other options, the IFS says.
“There will be some for whom a retirement income default will not be right,” said IFS research economist Bee Boileau. “The government and pension providers must ensure that it is straightforward to opt out of whatever new defaults are introduced, and that as far as possible those making these decisions are sufficiently informed and helped."
‘The current system is clearly not working’
The IFS is also calling for measures to increase the take-up of advice, guidance, or a combination of both, saying this should be a policy priority as three-quarters (73%) of those in their late 50s with DC wealth in 2021–23 did not recall using any sort of information about pensions and retirement choices in the preceding three years.
Chief executive of the abrdn Financial Fairness Trust, Mubin Haq, said: “Financial decisions in retirement will become even more difficult as we age. This is made even more challenging by the myriad number of pension pots many will have to manage. Yet few take up advice or guidance. The current system is clearly not working. Consolidation of these pots and providing defaults on how to draw down retirement income will be essential.”
The Financial Conduct Authority is trying to address the advice gap and has proposed creating ‘targeted support’, a form of generalised advice that is less specific but goes beyond guidance, as support can be based on individuals being grouped according to certain characteristics.
The issue of advice and guidance could see improvements depending on the details – crucially, liability and fees.
On small deferred pots, the government is expected to legislate for auto-consolidation – default consolidators with a centralised clearing house – in the upcoming pension schemes bill. The IFS said people should end up with one or only a small number of DC pots through automatic consolidation to avoid hindering them from accessing their resources appropriately.
Other policies the thinktank proposed include: increasing the age at which private pensions can be accessed; and avoiding the expression ‘lump sum’ when explaining the 25% tax free amount, with the IFS saying this steers people towards taking this money up front when they could be accessing it gradually.
Lastly, it wants the government to invest in better data about household finances, saying people need an overview over their assets to make financial decisions. Policymakers also rely on good data; the thinktank claims the Wealth and Assets Survey, prompted by the Turner Commission, needs improving as “the quality and timeliness of the data currently fall below the required standard”.
Research by the People’s Partnership, which provides master trust the People’s Pension, has also found that older savers struggle with the decision they are forced to take at retirement.
Proposition director Kirsty Ross said: “It has become very clear to the pensions industry that the millions of people who will retire with only defined contribution savings will need much more support than is currently available. It’s important that these solutions provide a sustainable regular income for life, protect against inflation and are flexible.”
Ross pointed to the power of inertia, saying one of the reasons why automatic enrolment has been a success is that it does not require the individual to make ongoing decisions, adding: “It only makes sense that this support continues through retirement.”
Claire Altman, managing director for individual retirement at Standard Life, said the IFS reports correctly identify a lack of guaranteed income as one of the most significant challenges for retirees.
"We agree that blended approaches such as the ‘flex then fix’ model highlighted are part of the solution," Altman said.
On small deferred pots, the government is expected to legislate for auto-consolidation – default consolidators with a centralised clearing house – in the upcoming pension schemes bill. The IFS said people should end up with one or only a small number of DC pots through automatic consolidation to avoid hindering them from accessing their resources appropriately.
Other policies the thinktank proposed include: increasing the age at which private pensions can be accessed; and avoiding the expression ‘lump sum’ when explaining the 25% tax free amount, with the IFS saying this steers people towards taking this money up front when they could be accessing it gradually.
Lastly, it wants the government to invest in better data about household finances, saying people need an overview over their assets to make financial decisions. Policymakers also rely on good data; the thinktank claims the Wealth and Assets Survey, prompted by the Turner Commission, needs improving as “the quality and timeliness of the data currently fall below the required standard”.
Research by the People’s Partnership, which provides master trust the People’s Pension, has also found that older savers struggle with the decision they are forced to take at retirement.
Proposition director Kirsty Ross said: “It has become very clear to the pensions industry that the millions of people who will retire with only defined contribution savings will need much more support than is currently available. It’s important that these solutions provide a sustainable regular income for life, protect against inflation and are flexible.”
Ross pointed to the power of inertia, saying one of the reasons why automatic enrolment has been a success is that it does not require the individual to make ongoing decisions, adding: “It only makes sense that this support continues through retirement.”
Claire Altman, managing director for individual retirement at Standard Life, said the IFS reports correctly identify a lack of guaranteed income as one of the most significant challenges for retirees.
"We agree that blended approaches such as the ‘flex then fix’ model highlighted are part of the solution," Altman said.
“As the government prepares to legislate for default retirement income solutions, the paper acknowledges that two of the key enablers are a reduction in the number of small pots and increased access to guidance and advice. Everyone’s retirement will look different so creating a system that enables people to seek support to maximise their income, and one which gives them a comprehensive view of their total savings, is critical," she argued.
What should retirement defaults look like in your view?
