Yesterday I wrote about how Steve Webb sees the “real world” of pensions
Today I am focusing on how he sees choices through retirement and looking at two other ways in which we can hand over the decision on how we hand over our pots to others to get paid a wage for life.
I’ll be looking at these three alternative approaches brought to us by these three men in blue suits. None provides the same certainty as buying an annuity when retirement begins and all present different types of risk sharing.
- Later Lifestyle. The approach modelled by Steve himself involving a move from drawdown to annuity
- A With-Profits annuity; an approach sent to me by Steve Groves, former CEO of Partnership
- A modern tontine ; a CDC approach promoted by Dean McClelland being used in Australia
Before we look at these alternative approaches, Steve Webb asks us a fundamental question.
Do we need new products and a mid-retirement MOT?
There is a dilemma for those who advocate freedom, that freedom trends to anarchy. The loss of all governance in the taking of money from pension pots from 55 has led to an increase in scamming, the over-payment of tax on money drawn and the very real probability that most people will either run out of money in retirement of starve themselves of a decent lifestyle by hoarding their savings.
Most people are not taking advice on how they should spend their pensions, they aren’t even taking the free guidance on offer from Pension Wise . Worst of all, many people are convinced that they will be better off paying themselves a pension by transferring out of occupational DB schemes.
Pensions are a way of ensuring that you get your wage in retirement for as long as you need it, and many pensions provide protection so your family get protected too. The State Pension, which is the bedrock of retirement income for most people, does just this.
It is remarkable that the person who opened the door to pension freedoms is now trying to sort out the consequences – I’m made to think of Frankenstein’s monster.
This point has not been lost on social media.
Webb asks if we need products that default to an annuity. Buying an annuity is the only way for most people to guarantee themselves a lifetime income. There is a strong case for purchasing a product that defaults to an annuity – just as there is a strong case for purchasing a product that maximizes the value of your pot before you start saving it. Both could – and in my view should – be default products for fiduciaries to promote to those who save in their schemes.
Do I see a case for a mid-retirement MOT? It is hard not to promote people reviewing their plans as they get older. Let’s face it, we do this every time we look at the value of our savings – whether in the bank , in independent investments or in our pension funds. But do we need to be nudged into a more formal review – perhaps with Pension Wise – I’d say no.
We should not have to review our pension plans in retirement like we do the state of our car or our health, for most people , we need “set and go” products that provide predictable outcomes for as long as they are needed. For most people, choices for retirement are made on the basis of what’s available at retirement and plans are for sticking to.
So now let’s look at the three products from our men in blue
1. Later Lifestyle – from Steve Webb
Steve’s plan is a return to the lifestyle approach that prevailed in workplace pensions till the freedoms were announced. In the early years of retirement you take risk by investing in the equity markets and you then de-risk by moving to an annuity when your appetite for risk is overtaken by an appetite to have the security of a guaranteed income.
Steve’s thinking is that some people would be able to take more risk in drawing down assets if they had a proportion of their saving invested in an annuity at the outset of the plan.
There are issues here about protecting yourself against annuity fluctuations that could be resolved by a target date fund moving money into annuity like assets as the swap to an annuity approached. There are issues for people who find their life expectancy extending or reducing through retirement – and these might prompt reviews. But for the most part, a lifestyling style approach makes sense
2. The with-profit annuity – Steve Groves style.
Steve has written to me, proposing more thinking around with-profits annuities.
The biggest issue you have with annuity type products are like speed limits, people don’t really like them but they keep them safe. People don’t really know they need them but without them they have serious crashes. No one voluntarily chooses to have them , unless they are around their house .
Their second issue is that like most life insurance , annuity products are sold not bought and as only a small minority of us take any advice, the best annuity in the world won’t sell in volume.
The third problem is that the individual annuity market is £1-2bn pa and makes a lower profit margin or return on capital than providing drawdown whereas the bulk market is £40bn pa. It’s not in the interests of large incumbents to change the status quo, it suits them just fine on the whole.
The final one is the people like me who have the changed status quos in the market in the past won’t go near it, don’t trust the political or regulatory environment not to change while we are doing it (and we have discussed it as a group).
I really like With Profits Annuities, they need explaining and regulations make them hard to make work but the core smoothed income is a great idea.
I’ve designed a with profits annuity that effectively does that, you chose a percentage of the initial income that is guaranteed and the lower you chose the higher the share of bonuses you get, once bonuses are declared they are added to the guarantee so over time the proportion of guaranteed increased naturally and for a period after each bonus declaration you could each year, cash out and move the whole thing (or more of it) to a fully guaranteed annuity . You could also go the other way and reduce the guarantee and take more equity risk again.
3. The CDC Tontine – Dean McClelland style.
In 2017, Dean McClelland, Richard Fullmer and Jon Matonis and others published a whitepaper to deliver secure low cost Tontine Pensions based loosely upon the Forman, Sabin and Milevsky format under the brand Tontine Trust.
The new Pan-European Pension legislation which came into force in August 2020 specifically paves the way for other types of financial service providers to create new pension products that abide by the “tontine principle” which tontine PEPP products can be offered throughout Europe once approved in a single member state.
The idea is that members transfer pots into a fund which is managed as a CDC. The CDC plan pays a regular income using the levers of indexation conditional on targeted investment growth to ensure the fund neither over or underpays. Pay-outs are supported by new members and and are expected to be enhanced by mortality credits being given to surviving members of the tontine when another member dies.
The advantage of such a fund is that it does not need to be supported by an accumulation fund (such as will happen in Royal Mail’s CDC) nor need it be established by an insurance company (as an annuity). So it can be managed by an occupational pension scheme, such as a master trust and regulated under the master trust assurance framework. The master trust itself creates a captive market for new members (who don’t choose to transfer away).
Manual, automatic or taxi?
Another way of differentiating these three approaches is by comparing them for the amount of control they give you in your retirement income
Steve Webb’s lifestyle plan allows for a great deal of control both of the drawdown investment and the point at which the annuity is purchased. If it is a default, it’s got the option of manual transmission.
Steve Groves’ with-profits approach allows you the chance to dial up or down the level of risk you are taking – and the reward in terms of pension payable now and in the future. You might liken this to a vehicle with automatic transmission
Dean McClelland’s plan offers virtually no options once you’ve transferred into the CDC. It’s a bit like selling your car and relying on taxis (or maybe public transport).
We need to simplify pension choice to concepts people can understand. Then we can get a meaningful debate on how we go forward . Hopefully this blog goes some way to doing that.