National consensus required to ensure Government's 'freedom and choice' pension reforms are a success
The Independent Review of Retirement Income (IRRI), authored by members of the Pensions Institute at Cass Business School, has been published
A major review of retirement income, chaired Professor David Blake of the Pensions’ Institute at Cass Business School, has found that millions of pensioners are exposed to risks that they do not understand and should not be expected to manage themselves.
The Independent Review of Retirement Income (IRRI), recommends that a national consensus on the issue is needed if the Government’s ‘freedom and choice’ pension reforms are to be a success. The report also makes recommendations on how best to boost defined contribution (DC) savers’ retirement incomes.
The IRRI was set up by the Official Opposition to review the pensions market in the UK following the introduction of the coalition government’s pension reforms in 2014.
Professor David Blake, Chair of the IRRI and Director of the Pensions Institute at Cass Business School, comments:
“A great deal of effort will now have to go into re-establishing what a good pension scheme is. This will need a commonly agreed national narrative. Without this, people’s aversion to annuitisation combined with their willingness to pay highly for both flexibility and guarantees could leave them worse off than if they purchased an annuity to begin with. This is a significant challenge. But it is one that is well worth the effort because, as the Pensions Minister, Ros Altmann, says: “pensions are precious”’.
Key findings from the IRRI include:
Pension savers need significantly more help - There are significant risks involved in the generation of retirement income from pension savings, such as investment risk, inflation risk and longevity risk. Following ‘freedom and choice’, these risks are borne directly by DC scheme members. Unfortunately, many people do not understand these risks, even with improved financial education. Some risks have to be experienced before they can be genuinely understood, by which point it may be too late to reverse the damage caused by poorly informed decisions.
Auto-enrolment inertia v decumulation choice - If a large group of people cannot understand the risks they face, they should not be expected to manage these themselves. Instead, if there are well designed and regulated schemes which use retirement income products that manage these risks in the most efficient and cost-effective way, it might be possible to nudge or default savers towards one of these schemes. Can we build on the lessons of auto-enrolment by having a well-designed default decumulation process at retirement?
Appropriate products need to be developed - A good product for delivering retirement income needs to offer a combination of features, including: accessibility (the flexibility to withdraw funds when needed); inflation protection either directly or via investment performance, with minimal involvement by individuals who do not want to manage investment risk; and longevity insurance. No single product meets all these requirements, but a combination of drawdown and a deferred (inflation-linked) annuity does, for example. So a well-designed retirement income programme will have to involve a combination of products.
There is a need for ‘safe harbour retirement income plans’ - This would involve a simple decision tree with a limited set of pathways. This would allow people to get the best combination of retirement income products for them, given their assets, liabilities, health status, family circumstances, tax position, and risk appetite and capacity. The plan would be self-started following a guidance or advice surgery, and the plan member has the right to opt out until the point at which the longevity insurance kicks in. The plan would also deal with one of the important lessons from behavioural economics which is that too much choice is a bad thing. There are now far too many poorly designed and expensive choices of product available at retirement.
We need a ‘national narrative’ - Making decisions about retirement income are the hardest financial decisions people ever have to make, because the risks in pensions are so poorly understood. Getting it right requires a national narrative about what pensions are for. Everyone in Parliament – whatever their political affiliation – and industry has to sign up to this narrative – just as they did with auto-enrolment.
Making your money last - The unifying thread that runs through a funded pension scheme is the requirement to annuitise enough pension wealth, at the appropriate age, to provide an adequate lifelong income in retirement when combined with the state pension – which is the rationale for establishing a private-sector pension scheme in the first place. It is this requirement which makes a funded pension scheme different from any other type of savings scheme.
When annuitisation becomes optional, that unifying thread is no longer present and there is a real danger that the pension system begins to unravel. At best, it just becomes a tax-favoured arrangement for operating a multi-purpose spending pot – once the money has been spent for one purpose, it cannot be spent on another.
At worst, it becomes a honey pot for thieves and other opportunists. Lying between these extremes are millions of people now in control of their pension pot and who will be trying to do the best for themselves and their families. But for anyone who understands the risks involved in retirement income provision, it is clear that many of these people will find themselves in the same kind of control as a yachtsman in the middle of the Atlantic in a force nine gale.
Further detail on each of the key findings is available to view in the full press release.
The Review team are members of the Pensions Institute, an independent academic research centre, based at Cass Business School. They were asked to consider how to support a pensions market that works for all, retaining flexibility and choice on how savings are accessed and drawn down, while ensuring all savers, including those on low and modest incomes, are able to secure a decent and reliable retirement income. Their research, conducted over two years, involved consultation with key industry players and incorporates the findings of a hundred surveys and studies dealing with the reforms.