By Fiona Tait, Technical Director, Intelligent Pensions
According to this (and every other) report, the decision of when and how to take pension benefits is complex, and much as we might wish people to be more engaged with their pensions for some it is likely to be beyond their current competence.
This is not just down to a lack of understanding of the options available at retirement and often extends even after the decision has been taken. The PPI believes complexity is also driven by:
• Competing needs and preferences at retirement - while many people are looking for more flexibility and control of their savings, the more flexibility that is allowed, the more uncertainty and risk the individual is generally exposed to.
• Uncertainty around life expectancy – people generally underestimate how long they will live when they enter retirement and overestimate it when they are older, making it unlikely they will be able to accurately assess how long they will need income for.
• Varying consumption patterns - while some people experience a u-shaped spending pattern in retirement, on average spending will fall progressively as they age.
It is unsurprising therefore that consumers find it extremely hard to make the decisions they have to in order to increase their chances of achieving the optimal result.
Innovation
When pension freedoms were first announced the Treasury believed that many of these issues would be solved by product innovation, which has largely failed to materialise.
Unlike most other reports however, the PPI does not just bemoan a lack of product innovation but looks at where innovation is really needed. Thus, while noting the short timescale to design new products as well as the lack of competitive pressure to come up with new solutions, the PPI notes that there has been innovation through better planning tools which help people to compare products and model the potential outcomes of the decision they make.
Furthermore it notes that people who want both flexibility and income security may be able to achieve this by using a combination of existing products, for example drawdown and an annuity. This could involve the use of drawdown early on in retirement, when change is most likely to occur, followed by annuity purchase at a later age, when better rates might be available to those who have developed health issues. Alternatively the report suggests a deferred annuity could be bought at the outset, although this does mean a decision will have to be made up front, and it reduces the chances of being offered an enhanced rate.
A third option is to divide the pension pot in order to buy a drawdown plan and an annuity at the same time, with the annuity acting as an underpin to cover essential expenses. This option is typically available via hybrid products however, as was pointed out at the report’s launch event, a hybrid product is unlikely to offer both the most competitive drawdown product and the best annuity rate at the same time. Advisers would therefore tend to select these products separately, although there are certainly conveniences to be had by having it all in one place.
Advice and Guidance
The report also suggests a blended solution for advice and guidance. The majority of advisers believe that robo-advice will help to bring down the cost of delivering financial advice, making it more accessible to people with smaller pension pots. On the other hand the majority expressed concerns about whether it was likely to deliver the most suitable outcomes.
The answer may therefore be to use automated systems to collect personal information and provide relevant facts about the options available prior to a discussion with a financial adviser. It may also be possible to improve standards and reduce costs by delivering advice through the workplace, for those who are lucky enough to have an employer who will both pay for and facilitate it.
In the short term we may have to rely on the “default pathways” first suggested by the Treasury Select Committee. These are, in my view, even less likely to deliver an optimal result to a wide range of people with individual needs, but I believe it has got to be better than leaving them to misguidedly invest all of their funds in cash for twenty years.
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