The Pensions Institute at Cass Business School has warned the government that it risks turning private sector defined contribution pensions into a savings scheme that will not provide an income for life.
In a highly critical report, the research centre claims the “reckless” reforms could lead to thousands of retirees running out of money in their old age.
The white paper calls for the decumulation stage of defined contribution pension schemes to be “institutionalised” in the same way that auto-enrolment has institutionalised the accumulation stage and helped to provide good-value low-cost savings products.
“The Chancellor has forgotten the definition of a pension scheme, which is to provide retirement income for however long the member lives,” said Professor David Blake, Director of the Pensions Institute. “In his bid to offer freedom of choice, he fails to recognise the key risks associated with every pension scheme. The optimal running down of assets in retirement is extremely complex. A minority of individuals might be able to manage some of these risks on their own, but this is a risky and high-cost strategy. Importantly, the Chancellor must understand that it is impossible for an individual to manage longevity risk, except in extreme cases of terminal illness.”
The paper demonstrates the complexities involved in estimating life expectancy and shows that at in all age groups individuals significantly underestimate their remaining years. “Without longevity insurance in later retirement the scenario is stark,” Professor Blake said. “Even with the best planning, men will outlive their pension pot by five years and women by three.”
The report raises concerns that thousands of pensioners could end up “double dipping” – spending their pension savings quickly and falling back on state support. Some may actually do the opposite and take excessive precautions by hoarding their pension savings, thereby forfeiting a higher standard of living than they could have enjoyed. In both cases, annuities help pensioners manage their spending better.
To avoid fallout from the reform, Prof Blake calls for the development of a “decumulation product” that can be integrated into auto enrolment. He said there was an urgent need to move away from retail decumulation products, such as individual drawdown and retail annuities, due to the high costs and poor governance.
“It is essential that the decumulation stage of a DC scheme is institutionalised in the same way that auto-enrolment has institutionalised the accumulation stage, rescuing pension savers from the high-charges and poor investment strategies of retail personal pensions. In a similar way, economies of scale need to be exploited in the decumulation phase to enable good value drawdown products to be designed for the early stage of retirement and good value annuities to be designed for the later stage.”
How would a new decumulation product that can be integrated into auto-enrolment look?
The interim findings of a research study being conducted at Pensions Institute by Professors Debbie Harrison and David Blake are that ‘scheme drawdown’ would:
• Benefit from institutional design, governance, and pricing
• Deliver a reasonably consistent income stream (i.e., with minimal fluctuations)
• Maintain the annuity-purchasing power of the fund
• Is simple to understand, transparent and low-cost
• Require minimal consumer engagement
• Benefit from a low-cost delivery system
• Offer the flexibility to purchase a lifetime annuity at any time (or at regular predetermined intervals) to hedge interest rate and longevity risk
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