Money

Financial illiterates are in the dark about pension transfer risk 


After stock markets crashed last week, I checked my Sipp (self invested personal pension) daily and mulled whether to take the profits still showing. 

It is hard to make such decisions, but not crucial for me as my Sipp is my sideline pension provision. My main source of retirement income is a defined benefit pension scheme, where the investment risk lies with the provider of the scheme rather than me.

So my financial security is not too exposed to the vagaries of capital markets. This is not true for the majority of people currently paying into a UK private sector workplace pension plan: more than 10m are members of defined contribution plans, where the risk sits with the individual, while only 1.1m belong to defined benefit plans. In the public sector, 6.3m employees still enjoy defined benefit pension provision.

Pension scheme membership has risen dramatically since automatic enrolment was introduced in 2012, from 7.8m (active members) to 17.3m. This is generally regarded as a good thing, and is certainly good for pension providers collecting asset-based fees.

For the members of DC workplace schemes, the pay-off is less clear. They are exposed to investment and longevity risk but have little help or guidance in how to deal with those risks.

The same is true for those who have transferred out of DB schemes to take advantage of the 2015 pension freedoms. The Pensions Regulator estimates that between April 2016 and April 2019, there were about 400,000 transfers from DB schemes, with £47bn transferred out between April 2017 and April 2019.

The Institute and Faculty of Actuaries observes that pensions are just one area where risks previously managed by government, employers and financial institutions are increasingly being handed to individuals.

Insurance, financial advice and social care are others. It is looking at what is happening and what can be done to “help people become better equipped to manage risk” and has issued a call for evidence.

The institute’s proposals focus on improving consumers’ knowledge and the provision of products and services that meet consumers’ needs. 

In an ideal world we would all understand percentages, compound interest, risk and reward trade-offs and how to manage our money to last a lifetime. In the real world, innumeracy is normal and it is surprisingly easy to sell people pie in the sky and run off with their money. There is no simple fix for this. 

As for the provision of products that meet people’s needs, there is often a conflict between those needs and what makes money for a provider. There would be no need for a price cap on auto-enrolment pension schemes if providers could be trusted not to overcharge.

As it is, the price cap only applies to default funds in the build-up stage of pension saving. Providers can charge what the market will bear for drawdown funds, especially as Nest, the state-backed provider that looks after 8.6m auto-enrolled savers, is not currently allowed to provide decumulation products.

Nest this month launched a retirement hub, giving information on retirement options, along with a post-retirement fund, the Guided Retirement Fund. It will automatically move members aged 60 to 70 with pots of more than £10,000 into this fund if they do not choose otherwise.

This is another version of Nest’s accumulation funds, however, not a drawdown fund. The fund will keep most of the money invested while de-risking an annual amount that can be withdrawn if needed. 

In addition to protection from the depredations of financial institutions, what DC pension scheme members really need is protection from the fluctuations of capital markets, particularly when they come to draw on their pension pot. 

There was some built-in protection when annuity purchase was compulsory. There is none now. Annuities are still available but few choose to buy. Collective defined contribution (CDC) schemes, being introduced in the Pension Schemes Bill currently going through parliament, may offer a partial solution.

They have the potential to lower the risk of bad outcomes at retirement, and of running out of money during retirement, by pooling risk. It is not clear exactly how they might work though.

Auto-enrolment and the 2015 pension freedoms have created a strange mixture of reliance on inertia to get people saving, then handing them a choice most of them are not equipped to deal with when they reach retirement. The repercussions of this transfer of risk have not been properly thought through.



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