More than a year on from pension freedoms the transition to retirement is far from simple for most employees. Michelle McGagh hears advisers calling for a more flexible, seamless approach
Trust- and contract-based pension schemes are adapting their propositions to fit the new world of freedom and choice but more innovation is needed to enable a smoother transition into drawdown.
Greater numbers of employees, who are more reliant than ever on their workplace pensions, are keen to take advantage of the facility to keep their fund invested via drawdown, taking an income from dividends and returns.
The ability for employees to access drawdown varies between employers and depends on which scheme they are running: contract-based or trust-based.
Moving into drawdown from a contract-based scheme is arguably easier depending on the provider, says Barnett Waddingham partner Paul Leandro.
“We have some providers that allow drawdown directly from the pension pot and others that require a transfer,” he says. “Ideally they would accept drawdown but their administration platform will not allow it and the employee may have to move to a Sipp in order to access drawdown.”
The ability to access drawdown is now a crucial part of Leandro’s recommendation to employers when setting up a contract-based scheme.
“If full flexibility is available without the member having to make changes, that’s ideal,” he says. “Some providers offer drawdown with no additional charge while others are increasing their charges. If you use drawdown from age 55, they may increase the annual management charge by 5 basis points. It’s not that much but it covers the administration burden of drawdown.”
Punter Southall DC Consulting principal Neil Haigh says employers are becoming more likely to help their staff make the transition into a retirement product.
“Most providers will offer a retirement solution [like drawdown] but many need an internal transfer between products,” he says. “We are advising on what support can be given through employers to employees as they reach their designated retirement time.
“Employers do not want to dump their staff when they get to retirement and say ‘Here’s a fund of £100,000. Off you go.’”
While contract-based schemes have made a relatively easy transition to deal with the move to decumulation under the new freedoms, trust-based schemes have been lagging.
“DC trust-based schemes have been reluctant to offer full freedom because of additional risk and administration that lead to additional cost,” says Leandro.
Those trustees that are providing access are typically offering a limited number of cash withdrawals from the fund, “but very few are offering full drawdown so, if a member wants that, they have to transfer”, says Leandro.
Employers running trust-based schemes face a difficult decision over whether to continue the burden of staff pensions into retirement.
“For employers running the scheme themselves with a trustee board making the decisions, there is a reluctance to offer drawdown,” says Haigh.
“The legislation allows it but it is costly because the employer has to continue to administer the funds of someone who does not work for them and that could run on for 20 or 30 years. If you’re running a DC occupational scheme, do you want to burden that scheme with the cost of someone who worked there 20 years ago?”
Part of employers’ reluctance is due to the immature freedoms market, with trustees waiting to see which types of proposition and service evolve.
When it comes to trust-based schemes, Leandro believes the choice should not be just between buying an annuity or transferring away, the latter of which means disinvesting and reinvesting.
He thinks the popularity of lifestyle funds with pension schemes opens the door to a seamless transfer into a suitable investment process for retirement.
“We have an ideal in mind when it comes to investment,” he says. “During the lifestyling process, you have a de-risking element and the fund is invested in more bonds and cash. Ten to 15 years out from the retirement date, you determine if the member wants an annuity, drawdown or cash withdrawal, or a catch-all safety net.
“Trust-based schemes do not offer drawdown but do have a lifestyling strategy so there will be an investment stream-targeted retirement strategy.
“We would like to see the strategy transfer from the scheme into a drawdown product so that the transfer happens in specie or using re-registration.”
By allowing trust-based schemes to directly transfer members’ investments into a drawdown product, it would stop the burden of drawdown falling on the employer scheme and also prevent the member from being taken out of the market.
“If the member wants to take benefits, they have to transfer into something else. That means they have to disinvest, transfer and reinvest,” says Leandro.
The idea of in specie transfers between schemes and drawdown products “is out there” and the industry “is developing that”, he says.
“Arguably, it could be done now… the infrastructure is there. We would like to see a streamlining in the transition of assets from one place to another,” he says.
An increasing number of trust-based schemes are also having to allow partial transfers out of pension to protect employees who have built up entitlement to tax-free cash of more than 25 per cent.
“Where there are occupational DC schemes that employees have been in for a long time, it could mean they have tax-free cash worth more than 25 per cent based on the old rules,” says Haigh.
“They get to retirement and the only way to access drawdown is by going into a personal pension but, by leaving, the employees are being committed to a reduction in the tax-free cash to 25 per cent. Employers can help by allowing them to take tax-free cash from the scheme and transfer the balance into drawdown. It amounts to the employers changing the rules.”
Allowing partial transfers means employers are no longer effectively ‘penalising’ members, he adds.
“The larger employers running larger schemes are more willing to bear the cost [of partial transfers],” says Haigh.
The introduction of pension freedom means there is no ideal retirement solution that will fit everyone but Haigh says that, if someone has a reasonable-size pension pot – a minimum of £100,000 – flexi-access drawdown is likely to be a fitting solution.
“The ideal is you have capital investment and live off the growth,” he says. “This gives you the safeguard [of the capital] so you can always rely on the funds.”
He adds that the increase in people wanting to protect their capital and live off the growth will affect the way pension schemes invest.
“We do not know how people will take benefits and they will have to use individual solutions,” says Haigh. “Rather than de-risk, they are going into more diversified asset funds with lower risk than balanced managed funds.”
Leandro says there are a number of ways that members can invest to protect their capital and live off the growth created by their pension fund investments.
“There are investment solutions that target inflation and promote growth, and those with a capital preservation focus, while diversified growth funds are looking to reduce volatility,” he says.
He is less impressed with the number of guaranteed products coming to market that offer flexibility, income and growth.
“If the product provides a guaranteed income of 5 per cent and is still flexible, so you can cash it in at any time, the charges are high because the cost of any guarantee is high,” he says.
“It depends on the cost [as to whether more people will use guaranteed products]. When they hear the word ‘guarantee’, they become sceptical.”
The new retirement: managing multiple income streams
In the world of pension freedoms, retirement will be less about investment or drawdown propositions and more about service, according to Wealth at Work director Jonathan Watts-Lay.
The shift away from annuities towards drawdown is not just about pensions, he says.
“It is all about savings and Isa and share schemes: all the streams where you will have to manage income in the most tax-efficient manner over the next 25 or 30 years.”
Wealth at Work manages money in-house on a discretionary basis, which Watts-Lay says opens up this service – typically the preserve of the wealthy – to those with more modest savings.
“We manage the money based on income requirements; setting out how much money a person is hoping to get in retirement including all pensions and other assets… and we tell them if [their income figure] is realistic,” he says.
“If it is, we will manage the portfolio rather than buy a [retirement] product because it isn’t just about pensions.”
Watts-Lay says the technology behind the service enables it to be used by those with smaller pots.
“With this technology, we can make money [managing smaller sums] because we have an efficient platform where we can bulk-trade everything,” he says.