It’s been three years since the Government introduced fundamental reforms to how consumers can access their defined contribution (DC) pensions savings. These reforms have been popular but have significantly changed the pensions landscape. Twice as many consumers now opt for drawdown products than annuities [1] and many do so without taking financial advice . The long-term consequences of these decisions are not yet clear.
John Taylor, incoming President-elect at the Institute and Faculty of Actuaries, said: “We are seeing many more consumers moving towards products that don’t offer any income guarantee. There is a real concern that these consumers may be at risk of running out of money in retirement and that they do not understand this risk because of a failure to take regulated financial advice.
“Our modelling found that for those consumers who wish to use their pension pot to secure a sustainable retirement income, using drawdown until they are in their early-70s, and at that point considering whether to purchase some element of guarantee with their remaining funds, can improve consumer outcomes. This would be reliant on them withdrawing a sustainable amount during those early years, and our modelling suggests a rate of 3.5% per annum is highly likely to be sustainable.
“Consumers in drawdown are managing longevity risk themselves and it is impossible for anyone to judge exactly how long they are going to live and therefore how long they need money to last. While those who take an annuity at retirement will have a greater level of certainty, they will also have reduced flexibility over how much of their income they can take. Using drawdown followed by an annuity allows flexibility during the earlier stages of retirement and longevity protection at the end.
“These findings have implications for those advising and guiding consumers at retirement, as well as product providers. It also demonstrates the need to consider retirement planning as a series of decisions and not a one-off choice at the point of retirement.”
This analysis is focused on those individuals who are unlikely to seek advice, but who would benefit from improved information on their retirement options, as well as a range of hybrid-pension products, including default solutions.
John Taylor continued: “Managing long-term risk is a core actuarial skill. We have used our analysis to create a list of key questions to help consumers think about how they can ensure their pension pot sustains them throughout retirement, without forgoing the flexibility they might want in order to meet their own personal circumstances during the early stages of retirement. Although fewer retirees are currently choosing an annuity, we hope this briefing highlights the value of taking an annuity, maybe not at the point of retirement, but in later life.”
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