Andrew Pennie, Marketing Director at leading retirement income specialists Intelligent Pensions, looks at the issues and opportunities facing employers and their employees in light of the imminent pension reforms.
From April, anyone in the UK over 55 can access their pension how and when they want, providing flexibility never seen before. It is now predicted that only 40% of defined contribution (DC) pension scheme members will actually buy an annuity at retirement. With over 90% of these members in a default fund which is designed around taking 25% tax-free cash and using the balance to buy an annuity, that means that over half of members reaching retirement in the next 5 years are heading in the wrong direction with their pension.
Obviously that is a lot of company employees who will potentially be disadvantaged unless they are made aware of the problem and receive help to make the right retirement and investment decisions to suit their individual needs. Getting employees on the right investment pathway was a relatively simple process when most of them ended up buying an annuity at retirement, but with the new choices and flexibility available, the range of different retirement options and supporting pathways have suddenly become significantly more varied and complex. Everyone’s retirement will be different and to help your company employees maximise their retirement benefits, a different approach is needed.
Crucially, your company employees will need a way to decide whether the traditional tax-free cash and annuity in retirement is the right option for them. Despite the new flexibility, it is still likely to be the best option for many employees but it is important that this isn’t a passive decision and is one based on their individual needs. However, where it is evident the annuity option isn't likely to suit their needs they will certainly need individual guidance about how to position the investment strategy of their pension fund in the years leading up to retirement. This will, in turn, depend on the likely profile of their individual cash and income needs in retirement – Will they need all their tax-free cash up front or should they take it in instalments?; How much will they need to drawdown in the earlier years of retirement, and will their long term needs still be achievable?
These are all very difficult issues for your employees to analyse, but if they don't have a reasonably clear picture of how their pension fund needs to be drawn down it is likely to lead to a mismatch in their pre-retirement investment choice, bearing in mind that default fund strategies are almost always based on taking the 25% tax-free cash and annuity option. It is likely we will see an increase in generic drawdown investment strategies but these also have limitations and must be treated with caution. A generic drawdown strategy effectively assumes all drawdown investors will have the same retirement income profile which is totally unrealistic and will inevitably lead to some poor retirement outcomes.
To achieve genuinely better retirement outcomes in the new pension world, a more personalised and tailored process is required. Given the complex nature of the issues and implications, it is hard to see how any written communication covering all the issues can possibly be effective. Many existing employer initiatives, such as pre-retirement courses and/or access to a financial adviser, and the government’s ‘guidance guarantee’ (Pension wise), while extremely positive, will come within months of retiring which is too late for many employees who needed to take key decisions much earlier.
A range of cost-effective solutions are now available to help your company employees in the years approaching retirement. The solutions typically combine online tools and ‘one to one’ member consultations to help employees understand their pension options and make the right decisions at the right time. Many of the new solutions that have come to market, including our own Pathways service, are able to provide employees with the answers to ‘the big questions’ and are priced within a special HMRC £150 annual allowance, this means there is no benefit in kind assessment on the employee and the cost is tax deductible for the employer. Furthermore, the costs can be shared or payable in full by the employee via a suitable salary sacrifice scheme. As employers, you have worked hard to help your employees save for their retirement so why not give them the tools and information to help them engage effectively and maximise their pension savings in a way that suits their retirement needs and aspirations?
Example Retirement Income Model/Profile: