In my opinion , the answer to that question is no. It is a “no for the USA, for Australia, for the UK and it is a “no” for five reasons
- To achieve a sustainable advantage over a guaranteed pension , a drawdown fund has to take market risk; without adequate protection from these risks, vulnerable people will lose their income in later life – when these cases become public , there will be a scandal.
- People’s reasonable expectation of a pension is that it provides them with an income that lasts as long as they do, drawdown promises no such assurance.
- The logistics associated with each drawdown strategy being managed personally makes drawdown more expensive to operate – and more prone to operational risk
- The lure of larger pots (especially from CETVs) attracts scammers with unsuitable investment strategies. Drawdown pots are vulnerable to predators.
- The capacity to engage and take rational decisions on pot management reduces with age, the advantages of annuitisation increase with age.
This is not to say that drawdown is not a good product. It has many advantages. It provides considerably the flexibility needed by many who have variable cash flows in retirement and meets the needs of those who have income and capital independent of their pension. It is tax-efficient, especially when people die in drawdown prior to their 75th birthday and it is an effective vehicle for those looking to pass on retirement wealth to a future generation. It offers considerable investment upside to those who are confident of their or their agent’s investment expertise and of course it allows people to feel in control of their money in the way that annuities or CDC doesn’t.
Drawdown will remain the principal means of providing retirement income and capital growth for the mass affluent who form the bulk of the advised population in the UK. Drawdown will become increasingly important as this demographic matures and financial advisers will no doubt find ways to improve drawdown as demand increases. In terms of assets, drawdown will continue to grow exponentially.
Financial planners and wealth managers should not feel threatened by the question posed by this blog. The mass market – that comprises 75% of the working population (potentially some 30m customers) are in need of a different product which does not require the skill and planning of advisers, nor the engagement of a financially astute customer.
The evolution of a new “default decumulator”.
I remember attending trustee meetings in the 1990s when new workplace DC schemes (both trust and contract based) were being set up. Often I was selling the wares of my insurer and frequently I was told that a KPI for the prospective scheme was the level of self-selection from the new savers. Some DC schemes deliberately avoided setting a default to ensure that everyone took advantage of the wide range of investment options available. In practice, many trustees (and sponsoring employers), did not want to be responsible for a default going wrong and felt that the default was tantamount to a recommendation – with the implications that had for liability if things went wrong.
Stakeholder pensions changed that. Stakeholder Pensions – as well as capping charges, required a default by law. This transferred the responsibility for choosing a default from the trustee or sponsor to the stakeholder pension. The workplace pensions used for auto-enrolment continued the requirement for a default fund which became more attractive as – unlike other funds- its charges were capped at 0.75%, Many workplace defaults now account for 95%+ of saver’s investment strategies.
This shift over 20 years from targeting self-selection to accepting the advantages of herding, is in marked opposition to what has happened at and in retirement. Here the saver has no clear default. If in an occupational scheme, retirement options are at the discretion of the trustee, if in a contract based scheme – there are investment pathways. Universally savers are recommended to take financial advice.
To my mind, we are at the same point with “decumulation” as we were 20 years ago with accumulation. We are faced with a drawdown option that works for the mass affluent but not the mass market, with annuity and cash options for those who have their own ideas of what they want to do with their money, and with nothing that might in previous times be called a “scheme pension”.
Nest currently offers only the most rudimentary of retirement income products
When Nest polled their members in 2018, they were shocked to find that over a third of respondents thought that the Government pension scheme was buying them additional state pension. I very much doubt much has changed, The expectation that Nest will pay a regular income remains at around one third of respondents according to the more recent survey shared with the audience of a recent Hymans Robertson webinar.
This recent research from Nest suggests that of the 11m savers, only a tiny fraction (6%) are wanting to take control of their own money. Even among the small number of Nest members taking their own investment decisions (“higher risk”) the numbers taking charge of their retirement income are less than one in five.
The overwhelming message is that people do not have a plan. What is worrying for Nest is that Nest doesn’t have much of a plan (yet) , though that may change if the recent DWP consultation on decumulation leads to Nest being able to offer pathways, manage its own drawdown or even offer some kind of CDC scheme.
Is Nest a suitable scheme to provide drawdown?
In my opinion , Nest customers would struggle with drawdown for the reasons outlined above. To those need be added one extra factor, almost all Nest pots have been funded at 8% of band earnings and most for only a few years. Very few Nest pots are of a size to merit the attention of advisers and indeed the fixed costs of offering drawdown makes it an impractical solution for those with micro-pots.
Nest should instead, investigate offering an invested annuity within a pooled fund which provides certainty that money doesn’t run out and fiduciary management of the money in the pool (at scale). Nest could do this in partnership with an insurer who could manage the underwriting and pricing issues so that people got an income that was fair to their circumstances. Nest’s investment expertise could be employed to replicate the investment strategies within the accumulation portfolio and this approach could and should be sold as Nest’s pension . Of course it would not be a guaranteed pension , but it would offer more stable prospect of lifetime income than individual drawdown policies and it would be a lot cheaper to manage (with lower fees to participants).
The capacity to deliver such a default decumulator is already in place and – if Nest wants to see how it might work – it should talk to Q-Super and Challenger in Australia. It can also talk to a number of Australians in the UK who have been giving this kind of product a lot of thought.
Drawdown is a good product for the mass affluent and a bad product for the mass market. Nest should be bold and build a product for the mass market – allowing members who consider themselves affluent, to take their pots elsewhere and draw them down independently of Nest.
I look forward to selling Nest this strategy!