Freedom and choice in pensions: risks and opportunities
Jun 16, 2014 | REPORTS
ILC-UK analysis of the removal of the effective requirement to annuitise in the 2014 Budget.
The most sweeping pension reform of the end of the Coalition, is the end of the effective requirement to annuitise for a large number of people.
Following a detailed exploration of many of the factors likely to determine the choices that people could make at the point of retirement, we argue that there is an urgent need to address a number of issues in order to minimise the risks associated with the new freedoms:
• Effective innovation in products and services
The financial services industry has been set a significant challenge to develop new products and services that will meet the retirement income needs of individuals throughout the duration of retirement, while continuing to demonstrate the value of more traditional product offerings.
In developing new products – including income drawdown for the mass market – the industry will need to carefully consider the extent to which moderate savers are willing and able to bear financial market risk and subsequently whether or not these particular products match specific, individual needs. In order to achieve this aim, providers must prioritise the needs of the end consumer over the needs of the intermediaries who sell and distribute the products.
• The advice gap
The Guidance Guarantee must be part of a process of continuing engagement which starts well in advance of retirement and continues afterwards. As trusted third parties, employers will have a critical role to play in providing guidance before retirement and flagging sources of good financial advice where necessary. The pensions industry also has a vital role in this regard and must deliver clear and easily understandable communications with consumers to inform them of their choices.
Questions remain about the financial viability of providing advice to those with moderate sized pension pots and the capability of the advice industry to be able to do this on a large scale. In order to serve the mass market, cheaper, online or over-the-phone solutions may well be the way forward – particularly for those consumers whose financial circumstances may be relatively simple and can therefore follow a carefully designed decision-tree type process. The financial services industry, the Government and regulators must quickly decide how this can be delivered if we are to close the advice gap which threatens to exacerbate many of the risks associated with the new pension freedoms.
• Behavioural biases
Any mass market guidance and advice processes must build-in an understanding of how the macroeconomic environment combined with the behaviours and characteristics of individuals can induce poor decisions at the point of retirement and beyond. And there must be regulatory safeguards in place to ensure that rogue organisations and practitioners do not take advantage of these behavioural biases in ways that compromise the needs and preferences of the consumer.
As a minimum, the Guidance Guarantee must directly address some of the behavioural traits discussed below, including the systematic underestimation of life expectancy, the tendency to prioritise short term smaller gains over longer term larger gains and the tax and benefit consequences of taking all the pension pot out as a lump sum. In addition, it should also provide generic and understandable information about the possible options facing individuals and their relative pros and cons. Finally, it should provide links to sources of good financial advice – whether that be face to face advisers or specific online tools.