PENSIONSANDSAVINGS.COM

14 October 2013

TIME FOR CHANGE:  Rethinking pensions and retirement

• Pension options not fit for the future as ‘low risk’ investments have become more risky and retirement becomes a process not an event

Auto-enrolment pension funds not fit for the future:  Retirement is changing, pensions need to change too. As auto-enrolment ensures millions of people are about to start saving in pension schemes at work, it is important to make future pensions fit future lifestyles.  There is a real danger of lulling employees into a false sense of security about their retirement incomes because current pension products are designed for the past, rather than the future.

Workers will be in risky and inflexible pension funds:  As the state pension is being cut and employers will no longer guarantee good pensions, auto-enrolment aims to replace the falling pension provision elsewhere.  But most workers will be put into defined contribution schemes, where the final pension depends on investment returns and annuity rates.  The inadequacies of the standard investment options being offered and the scandal of poor value annuities means that the pensions people ultimately receive are likely to disappoint.

Old age and retirement are changing, but pensions are not keeping up:  The survey work for this report highlights how retirement is changing. The majority of 50-60 year-olds do not expect to feel ‘old’ before their 70s, with more than a quarter saying they won’t feel old until they are in their 80s.  In addition, most people want to work part-time in later life, rather than suddenly stopping, as retirement becomes a process, rather than an event.  This means gearing pension saving to a specific future date is not appropriate.  More flexible planning is needed.

As people’s working lives will be more flexible – pension planning needs to be an ongoing process:  In future, there will be a range of ages during which people stop work, rather than one pre-set age, with a phase of part-time work in later life.  But most pension products have default funds that assume retirement will occur fully at a pre-determined date.  ‘Lifestyle’ funds or ‘target date’ funds aim to provide a pension income from a particular age, set several years in advance.  This is no longer appropriate, so pension planning will need to become an ongoing process, rather than just a one-off exercise, to cater for longer working lives.

Pension funds are geared to buying annuities but advisers do not believe this is best:  Most pension scheme default funds also assume that, on retirement, workers will buy an annuity.  Investments are often automatically switched into ‘low risk’ bonds in the run-up to the pre-set ‘retirement’ date, in order to reduce the risk of loss just before retirement and to prepare for annuity purchase.  This strategy may be wrong on two counts.  Firstly, workers may not actually buy an annuity.  Secondly, the bonds that are bought may turn out to be more risky than expected.
Only one in ten financial advisers would buy an annuity at current low rates:  The poor value offered by annuities at the moment, partly caused by the suppression of gilt yields resulting from Bank of England gilt-buying, is clearly recognised by financial advisers.  The MetLife survey showed that fewer than one in ten financial advisers would buy an annuity now, even on an impaired life basis.  Yet most workers currently believe this is what they have to do with their pension fund and most of the pension funds are geared to annuity purchase.

Gilt investments have lost around 10% of their value since August 2012 – hardly ‘safe’:  If workers are not buying an annuity, then gearing their investments to annuity purchase will not be right.  In addition to this, switching their investments into what are considered to be ‘low risk’ bonds in order to protect the pension fund may also be inappropriate because these bonds may not work as assumed.  In the past year, an investment in government bonds could have lost 10per cent of its value as gilt yields have risen.  Hardly ‘low risk’.  This way of protecting pension funds before retirement has let many people down.  They would have been better staying invested in the stock market than losing money by relying on ‘safe’ government bonds.

Pension thinking needs to recognise the new retirement realities: Standard workplace pension schemes may be poorly designed for the future.  The assumption of fixed retirement dates and switching to bonds to fund annuity purchase may not fit future retirement realities.  Unless we address the inadequacies of the current pension fund default options and the scandal of poor value annuity provision, pensions are likely to disappoint.