Michael Johnson: Nudge savers into default drawdown and annuity at 80

Pension savers should be automatically nudged into low-cost default income drawdown plans at age 55, allowing withdrawals of between 4 and 6 per cent a year, CPS fellow Michael Johnson has proposed.

JohnsonIndividuals’ residual pots should then be automatically nudged into annuitisation when they reach age 80, to remove later life exposure to investment markets and in acknowledgement of the increased impact of mortality cross-subsidy in later life. The regime would be optional, but providers would be required to offer it and it would stand as the default in the event that individuals did not engage.

Describing the concept as ‘auto-protection’, Johnson argues pension freedoms should only have been brought in on terms that ensured both individuals and the state were protected from downside risk. The report considers the reintroduction of a minimum income for accessing pension freedoms, of possibly £15,000, but rejects the idea on the basis that it would be unpopular with the public.

The central thrust of the report has been supported by the PLSA although some critics have questioned whether drawdown at 6 per cent is sustainable.

Johnson says: “The introduction of auto-protection would address a major policy inconsistency, whereby the state nudges and incentivises people to accumulate retirement savings, only to desert them at the start of decumulation.

“Any debate about what is the “right” form of defaults at 55 and 80 should not be allowed to overshadow a more fundamental issue: the pots of most people at retirement are likely to be too small…We have to recognise that unless working life savings contributions are substantially increased – i.e. doubled – then many people are likely to run out of money before dying irrespective of the design of any retirement default.”

Royal London pension investment strategy manager Lorna Blyth says: “We know from our income sustainability heat map that a 4% per annum income withdrawal rate is highly sustainable, with a 95 per cent likelihood that this will be achieved over a 20 year term for those aged 60 to 80 years of age. However, a 6 per cent per annum income withdrawal rate is only moderately sustainable, with a 63 per cent likelihood that this will be possible.

“What this really highlights is the importance of financial advice in retirement planning in order to understand people’s individual circumstances and needs. It is dangerous to sleepwalk people into income drawdown without giving them an understanding of the risks and trade-offs that could impact their standard of living in retirement.”

Pension and Lifetime Savings Association deputy director DC, lifetime savings and research Nigel Peaple says: “Michael Johnson’s paper joins a growing consensus that retirees should not just be left to make complex financial decisions without support. His proposals for a simplified drawdown product on retirement backed up by a default annuity at age 80 deserves serious consideration. It will be important to support such an initiative with advice and free guidance. Good consumer outcomes are vital and we need to make sure that the path of least resistance leads to the stable retirement income retirees say they want.”