Nest has launched a blueprint for a core strategy to meet the freedom and choice reforms that envisages mass market income drawdown and gradual purchase of secure income.
Developed following a consultation with stakeholders, the blueprint identifies three key building blocks – an income drawdown fund a cash lump sum fund and a later-life protected income fund – for three different stages of a lengthy retirement.
At age 65, or when the member needs a retirement income, around 90 per cent of the member’s pot would be invested in an income-generating drawdown portfolio that would pay income into the member’s bank account, aiming to give a very high probability of paying a steady income for 20 years, increasing annually to help keep pace with inflation.
The other 10 per cent of the member’s final pot would be allocated to a fund invested in cash-like money market instruments. In the first instance it is from this fund that savers would be able to take out lump sums as the need arises. This separate, low risk and liquid fund would be designed to reduce the need to sell assets from the income drawdown fund to provide the member with ongoing access to lump sums.
Nest proposes that from age 65 to 75, as well as paying out a monthly income, a small allocation would be taken from the pot to go towards securing a later-life protected income. The contribution is set aside and invested with the objective of securing an income later in life. Nest modelling and discussions with industry suggest the level of this contribution should be around 1.5 to 2 per cent of the pot annually.
At age 75, later-life protected income allocations would be locked in. At this point this money would become part of a mortality pool that would pay an income for life at age 85 that. Nest says this mortality pool could be managed in a number of ways.
Nest proposes that members would progressively purchase deferred annuities by slicing off a regular premium from their monthly income payments distributed by the drawdown arrangement. Whilst they have not yet been able to put a price on the deferred annuities, Nest projects that this package of measures could deliver an income of 4 per cent a year, inflation-linked up to age 85. A level annuity would typically pay around 6 per cent at current rates and a drawdown plan purely distributing the income from the underlying investments would pay around 3.5 per cent says Hargreaves Lansdown.
When a member reaches age 85, the income they receive as they move into the third phase of retirement would be broadly the same as in previous phases says Nest. The blueprint says the aim would be that the monthly payment one month after their 85th birthday should be the same or similar to the payment on their 85th birthday. However, subsequent payments post age 85 in this blueprint strategy would be the same nominal cash amount each month.
Prior to age 75, allocations would remain liquid and could be returned to the member’s estate or their nominated beneficiary.
Nest chief investment officer Mark Fawcett says: “Since the pension freedoms were announced the challenge to industry has been to help savers achieve a sustainable retirement income without removing freedom and flexibility.
“We believe this is possible but it requires innovation. Many of Nest’s members are the first generation of savers who’ll rely almost entirely on their DC pots and their state pension in retirement. This makes it absolutely critical that we get this right for them.
“We’ve developed an evidence-based blueprint for how to meet members’ needs. We hope this will stimulate the innovation necessary for us and others to deliver what members will need and want.”
Hargreaves Lansdown head of pensions research Tom McPhail says: “Nest’s research echoes market experience of the first weeks of the pension freedoms, with investors overwhelmingly favouring drawdown ahead of annuitisation, for now at least. They have some good ideas here, however their proposals do set a couple of interesting challenges. Insurance companies have shown precious little appetite for developing a deferred annuity market, though perhaps Nest’s blueprint will now stimulate more interest. They will also bump up against the challenge of communicating drawdown risks to their customers, some of whom are likely to be relatively disengaged. The FCA is unlikely to look kindly on a solution which involves putting disengaged investors into a risk-based retirement income solution.
“We also know that to date, investors have shown no appetite for buying deferred annuities, so packaging this up in a way which is attractive to investors could be challenging and complicated.”