The Chancellor, George Osborne, has fundamentally changed the pensions landscape with his Budget announcement heralding the lifting of restrictions on how pension savings can be spent. The removal of the old presumption in favour of annuities means, we believe, that ‘pensions’ will increasingly be seen less as a way of creating an income in retirement and more as a flexible savings vehicle, as they are in the US.
Trustees and others involved in defined contribution pensions are clearly bracing themselves for the challenge. An overwhelming majority is now expecting to have to offer multiple default approaches for members in the last stages of their career before retirement. We believe that is realistic. Defaults will now have to match the freedoms members will have over their pension pots – take the cash, move into drawdown, buy an annuity or use a combination.
We believe that flexibility will be crucial for most older members in this new environment. They may need to preserve their wealth in the last five to 10 years from retirement to give them the widest range of options when work stops. Any default fund with this aim will therefore need to offer fairly solid protection against unwelcome market falls – after all, a member approaching retirement would find it hard to recover from losses such as those experienced in 2008. But to truly preserve wealth, his or her fund will also need to combat the corrosive effects of inflation. So the member may have to accept some risk if they are to generate the inflation-beating growth they need.
We think such an inflation-plus target should be entirely achievable using a low-risk, diversified, multi-asset portfolio. By adding a variable volatility overlay, we think it would be possible to provide a mechanism aimed at putting a floor under losses.
Of course, some members may know in advance that they will want to buy an annuity. They may have paid off their mortgage or expect to realise cash from other sources. For them, a fund that removed some of the uncertainty about the level of annuity they could expect might provide peace of mind in the run-up to retirement.
Whatever individual members decide, we believe the Osborne reforms could provide a much-needed spur to pension saving. Now both providers and trustees need to rise to the challenge, starting a conversation to see how new investment solutions can create the sort of defaults that members need to exploit this new environment effectively
Contact us if you would like any further information on effective retirement planning.