The Budget stops the “requirement” to purchase an annuity. It has not been a requirement for a long time, but it has been the only effective option, and a powerful default option, for most retiring DC members. But the Budget has not taken away the need for a large number of people to generate an income from their DC pension savings, and CDC has a key role to play here.
For many people, the Budget flexibility will give them an opportunity to “cash out” at retirement. This will typically be individuals at both ends of the income scale. For people on low incomes, with relatively small savings pots, their best strategy will almost certainly be to cash out their savings and to spend it in a relatively short time. These people are protected from poverty in retirement by their reliance on the enhanced single State Pension – now set above the means testing threshold. Pension saving is now a way of accumulating a lump sum on retirement to have some fun with.
At the other end of the income scale, people with very large DC pots will probably roll over out of their employers plan to a SIPP or other Decumulation strategy offered by their adviser or other intermediary. They will value the new found flexibility and can incorporate it into a personalised financial planning strategy that will continue throughout their retirement.
As ever, the true need for pensions will centre around the “squeezed middle”. These individuals will want to use their retirement savings to generate an income to live in retirement – but they will also want to use some of the Budget flexibilities to cope with life after they retire. They could use part of their DC savings to buy an annuity – but many will not, or will defer this until much later in life. They will be looking for some form of income generating solution – and we can expect a proliferation of market innovation to fill this need, with guaranteed products, with profits annuities, variable annuities and newer strategies all coming into play. And CDC has a role to play here too.
Many employers will take the view that their role in pension savings is simply to contribute – what individuals choose to do with their retirement savings is no concern of theirs. Others will take a more responsible role and will see that their role is to help individuals to generate a stream of income in retirement – we could call that a pension! This is more than paternalism – it is recognising that it suits employers if their employees can retire in an orderly fashion. Employers set up pensions today because they can do a lot of the thinking for individuals, and arrange matters better on a group basis than an individual basis. That is why they negotiate better investment solutions on behalf of members, and why some of them will look to put in place better retirement income solutions for members. Market innovation will undoubtedly give rise to multiple approaches – but CDC can have a strong role to play here. It deals not just with the investment process – more effectively on a collective basis than an individual basis – but it also takes away what will become an increasingly complex decision making role in relation to Decumulation.
We can envisage that CDC will form part of a core delivered by an employer. Consider the changing income needs of a pensioner, and how individuals will meet those needs. The diagram below is taken from our 2014 Conference series which was arguing for pension flexibility! On top of the newly enriched Single State Pension, will sit a CDC “core” – paid for by the employer, with no cash option, and with contributions of say 8% of pay. Individuals can save more themselves –perhaps even matched by their employer. These individual savings – the golden box in the diagram – will be highly tax efficient: tax relief on the way in, tax free roll up, tax free out (up to 25% of total pension value) with full unfettered access to the remainder of their DC pot, after the Budget. The Budget flexibility means that individuals can address their variable, changing needs in retirement, with the security of a basic retirement income from the CDC core and state pension.
We can also consider CDC in the context of how DC pension investment strategies will change post Budget – some initial thoughts are set out in the diagram below. Some schemes will change their “exit” strategies to deliver cash, as discussed above. Some people will still purchase annuities. But many will want the income solution – which could involve CDC, either throughout the membership, or as a specific decumulation strategy.
Some other Budget related observations:
Decumulation strategies need to cover not just pension related matters, but also non pension assets, given the substantial increase in ISA limits and increases in personal allowances
Workplace strategies – combined pensions and corporate ISAs – can be expected to become much more popular, given the increasing numbers of people cut out of pension provision. We already had younger workers for whom pensions were remote and high earners taken out by the Lifetime Allowance. To this we can add anybody who accesses their pension pots after age 55, while still working; they will almost certainly not be able to make any further pension savings.
Solutions to outliving savings will become more attractive – such as Older Life Deferred Annuities (OLDA) from age 80. These could be combined with death in service premiums to reduce the cost. Of course CDC addresses outliving savings, and in a more efficient way by pooling longevity risk, than individual solutions.
Long Term Care solutions will be needed and expected by the Government, given the greater flexibilities individuals now have.
This post was first published in http://www.pensionplaypen.com/top-thinking