In his comments following the IFS webinar, Patrick Hosking takes on the problem of the “Generation DC”, a group of people for whom there is nothing but the State Pension between them and a pension-less retirement.
George Osborne did for annuities and they have not sufficiently recovered to call them a default.
Today few new retirees buy an annuity. The majority prefer to stay invested in the stock market, at least for a while, and draw down income from a pot that they hope will continue to benefit from stock market returns. Annuity sales dropped by 75 per cent between 2013 and 2024.
My understanding is that the majority of pots that are voluntarily swapped for annuities is still small and that the majority of people’s “decision” to benefit from stock market returns is because that is where they are stuck from advice or from the default positioning of their DC scheme (contract or trust based).
A juggernaut of growing DC balances is coming down the tracks. Getting the decision right is becoming more important for more people with every passing year, according to two timely reports from the Institute for Fiscal Studies. Median DC wealth will rise from about £75,000 for those born in the early 1960s to around £130,000 for those born in the late 1970s.
The “rule of thumb” for those with DC pots is to draw 4% and to expect there to be residual capital in the pot to pay an increasing amount each year hoping that market growth will offer some inflation protection (a rising income).
For those who believe in “flex and fix”, older people (in their 60s onwards) can decreasingly stand the stress of monitoring the capital in the pot and will find a moment when they must “fix”, by buying an annuity. But this looks like another part of the “nastiest problem in finance” highlighted by Bill Sharpe.
“The nastiest, hardest problem in finance.” That’s how Professor William Sharpe, the Nobel Prize-winning economist, described decumulation.
This is why the IFS brought to the table Nest – in the form of Paul Todd who I hold in high regard personally and for what Nest say about helping 13m savers with a problem they never asked for.
Patrick Hosking quotes the IFS reports that I re-publish at the bottom
Longer term, the figures become larger still. Even the lowest earners can expect to accumulate a £150,000 pot by retirement age under auto-enrolment rules. Average earners should be on course for £320,000. That compares to an average house price value today of £270,000.
These include people saving in Nest, it’s important for people to take seriously what they are doing staying in pensions (for around 10% opt-out and a big slice of the population are outside auto-enrolment). The fact is that the state pension is the most important promise most savers will have , 4% of £320,000 is only about what the state pension gives today and by the time we get to pots being worth that amount, the state pension will have at least doubled.
The point is that people are as mystified about what their “DC pension” is going to give them. The projections they are gong to get from the pension dashboard will at least allow them to recognise that a lifetime income (even a non-inflated one) is going to make DC savings a meaningful pension any time yet.
Nest are considering CDC, a pension with inflation protection linked to market performance not the amount of inflation at the time. This “conditional indexation” means that in time, Nest will embrace a system to insure longevity, either internally (a mutual model) or through reinsurance or similar.
What Nest have concluded is that while the wealthy will continue to have access to advice on how to do things (or prods from their technology), the vast majority of people, faced with the nastiest, hardest problem of retirement, will duck it, taking whatever their pension scheme defaults them into.
I am pleased that Patrick Hosking is reporting to Times readers that decumulation may become easier through “default decumulation” from the DC scheme but he clearly studied the reports and didn’t hear what Nest had to say.
In my view, Nest’s statement that they are heading to being a kind of CDC provider for their 13m future pensioners is the most important statement we have had on pensions in this debate. It is intent and not commitment, but it takes us beyond the deferred annuity purchase that “flex and fix” represents and offers future pensioners the opportunity to consider their pension scheme as more than a savings plan, more than a work sponsored pot.
