Private sector employees are increasingly accumulating retirement
savings in ‘defined contribution' (DC) pensions (pension pots
that do not guarantee a regular income through retirement). Since
2015, people over 55 have been able to withdraw money from DC
pensions in any way they choose.
As this form of wealth becomes more important, people face too
many complex and risky decisions through retirement. This
increases the risk many exhaust their private resources and fall
back purely on state pensions and benefits, especially later in
retirement. Reforms are needed to make the system easier
to navigate successfully in order to help reduce this
risk.
This is the key conclusion of the latest reports of the Pensions
Review, led by the Institute for Fiscal Studies in partnership
with the abrdn Financial Fairness Trust. The reports find:
The number of people making complex and consequential
financial decisions about their pension wealth in retirement is
rising substantially:
- Defined contribution pension wealth is becoming increasingly
important. Median (middle) DC pension wealth (for those
with some DC wealth) at retirement is set to rise from around
£75,000 for those born in the early 1960s to around £130,000 for
those born in the late 1970s.
- Unless people have significant traditional ‘defined benefit'
(DB) pension wealth, or they have bought an annuity (an income
for life), people face a risk of exhausting their private pension
wealth because they have lived longer than expected, and
therefore seeing large falls in their income. This is a
significant risk: our new analysis shows that, among 66- to
74-year-olds with private pensions, 40% of retired
singles, and 45% of couples, would see their income more than
halve if reduced to just relying on state support.
Encouragingly, the government is bringing forward a
Pension Schemes Bill to help address this issue. It is
expected that pension providers will be required to provide
default retirement income solutions:
- For many, a ‘hybrid' solution, in which – by default
– people are able draw down on their pension wealth flexibly
earlier in retirement, but annuitise their pension (buy an income
for life) at older ages (e.g. at 75 or 80), would work
well. This has been termed a ‘flex then fix'
model. It would provide a balance between flexibility earlier in
retirement and security later in retirement when people are more
likely to experience cognitive decline.
-
But this kind of default solution will
not be right for everyone. In particular,
those with significant traditional DB pensions (e.g. if
they have previously worked in the public sector) may have
particularly good reasons not to want to buy an annuity
with their DC pension pot. It may not work well for those
with health issues that significantly reduce their life
expectancy. Pension providers may well not know whether
either of these cases applies.
-
Defaults should therefore be ‘soft', with a menu of
alternative options provided to make it easy for people to
choose other sensible options.
-
Boosting the take-up of advice,
guidance or some combination should also be a policy
priority. 73% of those in their late 50s with DC
wealth in 2021–23 did not recall using any sort of
information about pensions and retirement choices in the
last three years, and this includes substantial numbers of
individuals with reasonably large accumulated pensions.
Bee Boileau, Research Economist at IFS and an author of
the reports, said:
‘The forthcoming Pension Schemes Bill is expected to introduce
default retirement income solutions. Done well, these should
improve outcomes for many, given the risks many face when drawing
down pension savings through retirement at present. But key
questions remain – in particular, there will be some for whom a
retirement income default will not be right. The government and
pension providers must ensure that it is straightforward to opt
out of whatever new defaults are introduced, and that as far as
possible those making these decisions are sufficiently informed
and helped.'
Mubin Haq, CEO of abrdn Financial Fairness Trust,
said:
‘With a decline in pensions and products that provide an income
for life, individuals increasingly bear the risks and
complexities of managing their pensions. Financial decisions in
retirement will become even more difficult as we age. This is
made even more challenging by the myriad number of pension pots
many will have to manage. Yet few take up advice or guidance. The
current system is clearly not working. Consolidation of these
pots and providing defaults on how to draw down retirement income
will be essential.'
ENDS
These reports are from The Pensions Review led by the Institute for
Fiscal Studies in partnership with abrdn Financial Fairness
Trust.
