NatWest’s Market Insights on turning pots to pensions.

NatWest produce an excellent round up of pension news; you can read it here.

I am interested in their views of how the Pension Schemes Bill will play out. They make an interesting point that there could be alternatives to the “float and fix” strategies that have been promoted so far.

Here is what they have to say..

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Topical update – Part II – Default decumulation solutions

 The other aspect of the Bill that deserves some additional attention is the requirement for DC providers to offer a default decumulation solution, or as the Bill calls them, “default pension benefit solutions”.

  In the accompanying “roadmap”, this area is referred to as “guided retirement”, and it suggests that mastertrusts will need to begin complying with the regulations and rules in early 2027, with single employer trusts complying in early 2028.

  Whilst the Bill only refers to trust-based schemes in this regard, the Government has confirmed that it will work with the FCA to develop similar equivalent requirements for providers of SIPPs and GPPs as well.

 

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So what does a default pension benefit solution actually mean?

  According to the Bill, such a solution should be designed to provide a regular income for the eligible members concerned in their retirement (whether or not together with other benefits). It would also require the choice of solution(s) to take account of the “needs and interests” of the membership as a whole, and appropriate subsets.

However, the Bill itself leaves certain key points to be defined. For example, what it means to be “designed to provide a regular income” and what “retirement” means. These may seem trivial, but are in fact crucial – does “retirement” mean beyond a certain age, for example, or once benefits have been crystallised?

Whilst the new Government could put in place secondary legislation or regulation that results in a different outcome, as it stands, we look to DWP’s response to their decumulation consultation (admittedly under the last Government) for what its intention might be.

  

Whilst this points to a “flex first, fix later” design (likely ruling out default annuitisation of residual pots at retirement), the 2025 roadmap does only really note the first two objectives.

We  have seen some providers publicly announce initial plans for decumulation solutions. Notably, NEST and TPT, which we discuss in more detail shortly.

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 Solutions to consider

  Below, we outline the key formats that a default pension solution might take.

  Annuities

• Self-explanatory – a regular income provided for life by an insurer
• Pros include security of income for life
• Cons include lack of flexibility in payment levels, changing approach (and it leaves nothing to be inherited)
• The lack of flexibility may render default annuitisation ineligible
• To the extent that annuities can feature in solutions (even if via a blended version – see later) this would likely involve the scheme partnering with a provider
• Scheme transfers, member consent and advice considerations all come into play with such partnerships, which we touch on shortly

 

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Alternative defined benefit pension provision

• Whilst a space that is still in its infancy, promising structures and proposals do exist
• Broadly, these can be seen as offerings which convert a pension pot to a defined benefit pension
• As these offerings fall under pension regulations, it is possible that more generous terms could be offered versus a PRA / Solvency UK-regulated annuity
• There may also be scope to share surpluses with members via periodic increases, for example, further enhancing member income
• Pension SuperHaven is one such idea, which could sit inside a mastertrust, for example. In case of interest, you can find a Pension SuperHaven briefing paper, here
• It’s worth noting that with-profits annuities have existed historically, offered by insures. However, these are significantly less commonplace (and typically much more complex) than standard annuities
• Cons again include potential lack of flexibility once implemented. One cannot generally transfer-out of a defined benefit pension once crystallised

 

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Managed drawdown

• In its simplest form, this could be, for example, withdrawing 4% of the pot per annum – generally considered to be a sustainable drawdown level.
• However, it is possible for providers to manage drawdown on behalf of members in a more calculated manner
• TPT’s proposed solution is an early such proposal. It looks to manage drawdown on behalf of the member, providing regular drawdown payments at a level that could be sustained to age 95, or 75 if the member intends on buying an annuity in later life
• The drawdown levels can take account of changes in pot values and retain the ability to flex in line with member needs
• Another advantage is the residual pot upon death remaining available for inheritance, unlike an annuity
• Unlike with an annuity or alternative defined benefit pension offerings such as Pension SuperHaven, there is no balance sheet to guarantee a level of income

 

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Blended solutions

• Such a solution would look to combine the flexibility of a managed drawdown solution, with the certainty of an annuity, for example
• NEST’s proposed solution is an example of this. Primarily, it provides managed drawdown designed to last for life. However, it is exploring the possibility of using a small part of the member’s pot at age 75 to purchase a deferred annuity starting at age 85. This would provide a backstop against longevity risk, backed by an insurer’s balance sheet
• It may also be possible to blend other solutions – for example, Pension SuperHaven have noted that within their offering, it becomes economically beneficial to buy-in members once they reach a certain age. Whilst the act of buying-in these liabilities might not be directly visible to members, it does provide the additional security that comes via an insurer’s balance sheet and FSCS protection, on top of that of the alternative defined benefit pension provider, and the PPF

  

Longevity pooling

• It may be possible to add a longevity pooling component to managed drawdown
• Take the Dutch variable pension (and similarly, Canadian Variable Payment Life Annuity) for example: here, members can essentially enter into a managed drawdown solution designed to last the member for life, with the individual’s pension adjusted depending on changes in the value of their individual pot
• When a member dies, the residual pot is transferred to the other members in the longevity sharing arrangement
• Importantly, this solution works even where members opt for different investment strategies, which also means that the potential membership is also maximised, increasing the robustness of the longevity risk pooling
• Of course, for a default solution (where the investment strategy is pre-determined) this option converges towards pure decumulation-only CDC, which we come onto next
• Whether or not such longevity risk sharing truly constitutes a CDC scheme, implementation of such a longevity sharing arrangement will undoubtedly need to wait for decumulation-only CDC regulations

 

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Decumulation-only CDC

• Whilst the UK already has legislation in place for whole-of-life single or connected employer CDC schemes, it does not have anything in place yet for decumulation-only CDC. We expect this to feature as part of the second stage of the Government’s Pensions Review, due to begin “in the coming months”
• A pure decumulation-only CDC would involve a collective investment strategy. There would then need to be a mechanism for increasing (or reducing) benefits. There are various options for this, such as notional investment strategies for members of different ages (generally decreasing with age) with increases or decreases based on this – akin to the Dutch solidarity approach
• The current legislation in the UK, however, for single or connected employer CDC schemes sets the approach for increases and decreases, whereby all members’ pension benefits to be uplifted by the same percentage, with this annual adjustment assumed to be applied in each future year as well. The increase can then be set to maintain a 100% “funding level”. This approach is also intended to facilitate a level of risk sharing between ages. In addition to this, the existing legislation allows for up to a three-year smoothing period in case of benefit reductions
• Whether this approach is carried through to any decumulation-only CDC legislation remains to be seen
• Decumulation-only CDC ticks a lot of boxes. However, we suspect it will not be possible to transfer out of a decumulation-only CDC scheme, which does beg the question of whether, as with annuitisation, it would meet any requirements to retain flexibility

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 Transfers and advice considerations

  Not all defined contribution schemes offer decumulation solutions. In fact, some may enable the notional allocation of funds to temporary drawdown, for the purposes of crystallising the pension and facilitating a lump sum withdrawal, but no permanent offering in practice.

  

In general, bigger schemes will find it easier to offer flexible drawdown currently (and other decumulation solutions moving forwards). As such, whilst we might expect mastertrusts to offer some of their solutions in house, and single employer trusts may look to partner with these mastertrusts or insurers to offer a default decumulation solution.

 Partnerships with third party provider come with their own challenges, however.

 Transfer of benefits to a new scheme on an individual basis, for example, requires member consent, and the Bill makes it clear that it does not override any existing legislation in this regard. Naturally, this means that the default solution is somewhat less “default”.

Bulk transfer of benefits may be achievable, if transferring from a scheme to a mastertrust. However, if a default decumulation solution is to take effect upon benefit crystallisation (e.g. taking a lump sum with no further investment decisions made), then it may be a challenge to achieve the critical mass needed. That being said, target date funds may help here, where cohorts of individuals are invested (in accumulation) on a common timeline. One might expect crystallisation from a number of members at the same time.

  The PLSA published a highly informative paper last year, “DC scheme decumulation on retirement arrangement and partnerships” on the topic, and suggests that a mirror bulk transfer framework may need to be developed for transfers to personal pension schemes (i.e. via FCA regulated SIPP or GPP providers) to be enabled.

  Currently, therefore, default annuitisation (without member consent) would not be possible. However, interestingly, alternative defined benefit offerings may be able to function “inside” a mastertrust, which could perhaps overcome this obstacle.

Finally, trustees will need to be highly conscious of not breaching the advice / guidance boundary with their default solution. As the PLSA notes, the “FCA’s and HM Treasury’s Advice Guidance Boundary Review says the boundary is not relevant where trustees provide a default solution in an occupational pension scheme. But trustees would need to communicate the default solution very carefully with members over a multi-decade period.” Having said that, default solutions may include FCA regulated products within them, or involve a transfer to an FCA-regulated provider, both of which make this somewhat of a grey area.