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Building trust in the pensions system

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Many pension scheme members don’t trust the system and, argues Simon Hubbard, this might only get worse for future retirees. We need to give savers a clear idea of what to expect when they retire.

In June 2018 the FCA published its first Retirement Outcomes Review. It gives some fascinating data on what DC pension scheme members are doing at retirement, but it also highlights a deep mistrust by many members of pension providers and financial markets.

About half of members accessing their DC pension pot are withdrawing the whole amount. Of these members, about half are then saving the money in a bank account or another investment product. That lays to rest some fears about pensioners spending their money all at once, but wouldn’t they be better leaving the money in their pension? Some of the reasons offered by these members were as simple as mistrust in their pension provider to look after their money or concerns about the Government changing the rules. However, they in turn lose the tax advantages of pension investment for no tangible benefit, simply because they don’t trust the system.

The same report looks at members who choose to leave their pot with their pension provider after retirement and allocate it for ‘drawdown’. This allows them to make withdrawals as and when they need to. Of these members, about one third have their pension invested in cash or cash-like funds. But by doing this they are missing out on significant potential future investment returns. The reasons for this appear to be members not realising they are invested in cash, or because they do not trust the investment markets.

Against this (so far rather negative) backdrop we have a great opportunity to build trust in the pensions system. Auto-enrolment has brought millions of workers into the pensions system for the first time and, we hope, their experiences have been positive so far. But there is a very real risk that their trust will fall away when they reach retirement and realise how little income their pension pot provides. Research by the Pensions Policy Institute shows that the average DC pension pot at retirement is currently about £25,000. In twenty years’ time the average will be double this, at about £50,000.

That sounds like (moderate) success for auto-enrolment, until we note that many people retiring with a DC pension now have some level of DB pension as well. In twenty years’ time most retirees will have only a DC pension plus whatever the State provides, and a £50,000 DC pot will simply not be enough. We risk people thinking they will be OK because they “have a pension”, with no understanding of what they will actually be in their pot by the time they retire.
Statutory retirement illustrations do not help here. We show members their projected pot at retirement - which looks like a big number - and their projected income if they were to buy an annuity, but many members will ignore this because they don’t intend on buying an annuity. For most members drawdown is the most likely option (if we can convince them to trust their provider and invest sensibly!) but this often isn’t illustrated.

To increase someone’s pension pot at retirement we need them to contribute more, but rising house prices and stagnant wage growth make it harder than ever for workers to put money aside for retirement. I would love to see people saving more, but I would settle for them simply understanding what their current pension contributions will get them. We need people to know what they can expect when they retire, what they could get if they contribute a little more, and what it might mean if they delay contributing more until later in life, as many will say they intend to.

It’s not only members who might be disappointed when they reach retirement though, and some employers will find that large numbers of staff simply can’t afford to retire when they want to. The days when an employer could ‘retire’ someone based on age are long gone so the coming decades could bring a significant rise in the average age of some workforces. Employers, as well as staff, should be prepared for the consequences of saving too little or too late.

Simon Hubbard, Actuary, Quantum Advisory