GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
Generation DC
ISSUE 1
Delivering the promise of
pension freedoms
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
2
FOREWORD
Pensions are undergoing a revolution.
As an industry, we can be justifiably excited
about this major overhaul of pension
legislation, which has introduced the most
radical change we have seen in a century.
When the Chancellor introduced these freedoms, he
spoke about the “trust” that we needed to place in
people who had worked hard all their lives. He meant
that we need to trust their good judgement and the
choices they will be free to make about their retirement
savings.
However, it is vital to remember that scheme members
and savers in turn place huge trust in their workplace
schemes and rely on their performance, which imposes a
significant responsibility on trustees.
DC pension funds and their advisers have a challenging
volume of change to manage, affecting investment
strategies and communication profoundly. LGIM has
therefore developed this series of articles to examine the
key issues which confront them.
Emma Douglas
Head of DC Distribution
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
3
INTRODUCTION
The rise of Generation DC
Generation X, born in the 1960s and
‘70s, is tagged as a cynical bunch
that doesn’t want to grow up. X was
followed by Generation Y, also known as
Millennials, who are famed as the first
digitally-savvy demographic. Generation
Z – those born from the late ‘90s onward
– supposedly buy their clothes in charity
shops, check their bank balances with
apps and recycle.
At face value, these groups do not
appear to have much in common. But an
overhaul of the UK’s pension rulebook
means that the generations will at least
share one significant experience: the
prospect of an entirely new retirement
landscape, different from anything their
predecessors encountered. This includes
both the way in which they accumulate
assets to fund their retirement and,
more significantly, the way those assets
are ‘decumulated’, or converted into a
retirement income.
When it comes to pensions, Generation
X may have some DB pension income
to look forward to, but Y, Z and their
successors are all part of the ‘Defined
Contribution Generation’ or ‘Generation
DC’. With most private sector Defined
Benefit schemes closed to new members,
the army of savers who will be largely
dependent on DC schemes is growing
all the time. Research from the Office of
National Statistics showed that in 2014,
for the first time since 1997, occupational
DB pension schemes represented less
than half of total workplace pension
membership in the United Kingdom.
At the same time, occupational DC
membership stands at 23%.1
When it comes to pensions, Generations
Y, Z and their successors are all part of
the ‘Defined Contribution Generation’
or ‘Generation DC’.
Generation DC in numbers
10
MILLION
BY 2018
It is estimated that auto-enrolment will increase the number of
individuals enrolled in DC workplace pension schemes2.
6%
Auto-enrolment — the average FTSE 350 employer has just a 6% optout rate for new employees4.
1 2014 Annual Survey of Hours and Earnings: Summary of Pensions Results, ONS, 26
February 2015.
Occupational DB — 49%; occupational DC — 23%; Group personal pension — 19%;
Group stakeholder pension — 7%; Unknown pension — 1%.
2 “Standing ovation as auto-enrolment hits 5 million and auto-transfer launch plans are unveiled”,
www.gov.uk, 11 December 2014.
£787
BILLION
DC assets to almost triple by 2024, growing at a rate of 11% per year 3.
3
OF FTSE 100
Number of FTSE 100 companies with Defined Benefit pension
schemes remaining open to new members5.
3 “2014: The year of the master trust”, Spence Johnson, January 2015
4 Towers Watson, FTSE 350 defined contribution pension scheme survey 2015
5 “Just three FTSE 100 companies remain with DB schemes open to new members”, Pensions
World, Jan 2015.
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
The ranks of Generation DC have been
swelled by auto-enrolment. Following
2012’s auto-enrolment legislation,
workers must put 1% of their wages
into the scheme, which is matched by
their employer. This will grow in the
years to come until, in 2018, workers
will pay in a minimum of 4% of their pay,
with 3% coming from employers and a
further 1% from tax relief. The number
of workers automatically enrolled into
a workplace pension across the UK
has now reached five million, according
to government figures published last
December – a milestone halfway point of
policy roll-out that aims to see 10 million
2
automatically enrolled by 2018.
It is widely recognised that even the
8% figure won’t be enough to fund
an adequate retirement,6 but at least it
is a framework to promote long-term
saving and goes some way to address
the inertia and lack of engagement that
people had with their long-term planning.
Freedom and
choice
4
concept of a pension. While the ins-andouts of the changes are well known, it is
worth reminding ourselves of the huge
degree of freedom it allows. The new
regime lets us tap into our capital. We
could, if we wished, simply spend what
we have taken a lifetime to save. Steven
Webb, former Pensions Minister, had
no illusions about the extent of these
freedoms, as his comment about the
freedom to buy a Lamborghini illustrates 7.
In his landmark 2014 budget
announcement, Chancellor George
Osborne took an axe to the traditional
PRE-APRIL 2015
The core changes of
Freedom and choice:
Regular income from an annuity
POST-APRIL 2015
• First, the end of the requirement to buy an annuity.
• Second, drawing cash out of your pension pot won’t be met
with a 55% tax rate.
• Above the 25% tax-free limit, you will pay your marginal rate
of income tax.
• These changes came into force in April 2015, alongside a charge
cap and emerging plans for a “pot-follows-member” system.
6 Assessing value for money in defined contribution default funds, Cass Business School and
the Pensions Institute, January 2014.
Regular income from an annuity, cash,
income drawdown
7 “Minister fuels pension debate with Lamborghini comment,” BBC, 21 March 2014.
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
For pension scheme trustees, these
landmark changes mean getting to
grips with a much more complex and
uncertain retirement landscape and
deciding how far their fiduciary duties
stretch into the decisions their members
make. Members will need guidance but,
with DC members now having access
to their pension pots, so the risks of any
mis-selling increase.
George Osborne described the reforms
as “the most radical changes to pensions
in almost a century”. But how will the
retirement landscape develop, and do
models exist elsewhere in the world that
could provide government and trustees
with some guidance in managing the
transition?
Opportunities
and a cautionary tale
“There’s some evidence that
people start to claim sickness
benefit or Disability Benefit in
the run-up to retirement,
resulting in a large kick-up in
benefit claims as people reach
State retirement age.”
The changes have been cautiously welcomed by the pensions
industry, which sees the end to compulsory annuitisation
as a positive, particularly for those with smaller pension
pots. David Fairs, chairman of the Association of Consulting
Actuaries (ACA) and a Partner at KPMG, suggests that, for
a typical DC pension pot of £30,000, buying an annuity that
offers £10-£15 a week will not help much in paying living
costs. For people on low incomes, however, being able to
access that £30,000 to bridge the gap for a few years before
reaching state pension age could transform their quality of life.
“There’s some evidence that people start to claim sickness
benefit or Disability Benefit in the run-up to retirement,” says
Mr Fairs, “resulting in a large kick-up in benefit claims as
people reach State retirement age.” Many people couldn’t
afford to retire because they had no flexibility on how to use
their pension savings, he explains, and they couldn’t access
their state pension early, “so they just claimed State benefits.”
The pension changes should benefit this group of people, he
believes.
David Fairs
Chairman, Association of Consulting Actuaries
For those with larger pension pots, income drawdown might
appeal, leaving a proportion of their DC plan in growth assets.
“Then, somewhere in the middle, there are probably people
who still want a secure, stable income but do not want to buy
an annuity around that,” Mr Fairs adds.
ACTIVE MEMBERS
on average in trust-based DC schemes vs. 4,500 for DB
8 “40th Annual Survey” NAPF, 3 December 2014.
8
5
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
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some mix of an account-based
pension and deferred annuity was one
example proposed. This would allow for
longevity risk pooling, which provides
an opportunity for higher consumption
streams for participating retirees.
According to Paul Trickett, Independent
chair of Trustees of the L&G Mastertrust,
while Australia had been “really good at
accumulation of DC, it was not very good
when it came to spending it”.
The Australian
experience
As the UK embarks on this virgin
journey of pension freedom and choice,
examining the ups and downs of a
similar experiment in another developed
economy may give pause for thought.
The Australian government introduced
compulsory saving – ‘superannuation’ –
and pension liberalisation 20 years ago,
but is now considering changes to the
scheme that would re-introduce some
form of annuitisation.
Research published by Australia’s largest
annuity provider, Challenger, indicates
that Australians are accumulating
debt in advance of retiring, using their
pension pots as collateral. The research
showed that just 4% of ‘super’ savers
purchased an immediate lifetime annuity
on reaching retirement, while 32% used
their pension pots to pay off a mortgage,
buy a new home or cover home-related
expenses. Just over a third paid off a car
or bought a holiday, and 27% put the
money in a savings vehicle outside a
‘super’, such as a bank account.9
As a result, concerns have grown that
Australian retirees who can access their
cash at 55 are running out of money
by the time they reach 70, leaning as
heavily on the (means-tested) state
pension as before.
Jackie Wells, Head of Policy and
Research at the National Association of
Pension Funds (NAPF) agrees, although
she adds that there are also countryspecific features to consider. “In
Australia,” she says, “it’s not unusual for
someone drawing down on their DC pot
to run out of money several years before
they die.” She applauds the retirement
income recommendations from the
Murray Inquiry introducing longevity,
protection, insurance and annuities – in
whatever form it takes to provide people
with an income for life.
In another report on superannuation
and retirement in Australia, published
in 2012, Alex Malley, chief executive of
the accountants association, CPA, said
pension savings were “being treated as
a windfall and being used to pay for the
lifestyle that’s been lived now instead
of being put aside to provide income in
retirement”. 10
“There are lessons to be learned,”
Ms Wells adds. “However, you have
to contextualise them, because what
happens in one country can’t necessarily
be lifted and put in place here. They have a
different history of pension provision, and
nowhere is as complicated as the UK.”
The government is now considering
recommendations from an independent
inquiry into the country’s financial
system to bring back some form of
compulsory annuitisation to avoid
retirees in their 70s and 80s running out
of money. The wide-ranging Financial
Services Inquiry, led by the former chief
executive of the Commonwealth Bank,
David Murray, observed that many
retirees found it challenging to navigate
the transition to the retirement phase of
superannuation. The task of managing
multiple financial objectives and risks in
retirement is complex, and the quality of
financial advice can vary significantly.
“In Australia, it’s not
unusual for someone
drawing down on their
DC pot to run out of
money several years
before they die.”
Accordingly, the Inquiry recommended
that institutional super funds be required
to offer their members a ‘pre-selected’
comprehensive retirement income
product which, where appropriate,
includes a regular and stable income
stream, longevity risk management
and some flexibility. A product involving
9 How much super do Australians really have? Challenger Retirement Income Research, 2012.
10 Pension freedom? Australia shows what can go wrong, citywire money, September 2014.
Jackie Wells
Head of Policy and Research, NAPF
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
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Along with choice –
complexity and risk
Industry commentators, while supportive of the UK’s sweeping reforms, point to a
number of potential pitfalls as the changes take root. Some point to the potential
for mis-selling and fraud; others warn that savers could – with the best intentions
– run out of money by underestimating the challenges of making drawdown deliver
sustainable income.
Reforms have strong
positives, as long
as people have a
comprehensive view
of the risks.
Emma Douglas, LGIM’s Head of DC Distribution, believes that the reforms have
strong positives, as long as people have a comprehensive view of the risks. “There is
certainly more complexity now but it’s a positive development. It’s helpful for savers
and should boost the popularity of pensions. I think the flexibility can be good news
for people, particularly at the lower income level. The state pension will be quite a
good replacement ratio for the income they’re earning whilst working and they may
see their DC pot as a ‘top-up’ to this income that they can dip into as required”.
“However, there will be an increase in the risk of people doing the wrong thing in the
retirement phase. You have to think about all sorts of things. How long will I live? How
can I counter the effects of inflation? What do I do with the cash? Do I buy an annuity
and if so, when?”
The three biggest challenges in the
new pension environment:
1. Low levels of engagement, investment abilities
and overall financial acumen.
The financial track record of UK
consumers shows that, as a nation,
there is legitimate concern about our
understanding of financial risks and longterm planning.
According to recent research from
think tank, Strategic Society Centre,
DC members over the age of 50 have a
low level of financial engagement with
inflation, stock market movements and
financial products. The Centre also found
that this got even lower with age.11
As an illustration of a collective failure
to grasp the merits of diversification,
there is a clear history of Britons placing
too much emphasis on property as part
of retirement planning. Research has
shown that as many as 2.5 million people
plan to downsize and sell their homes
to get enough money in the bank to pay
the bills in old age. And a further 3.5
million say they are planning to rent out
or sell another property.12 This narrow
focus occurs at the same time as high
household debt levels — in 2013 the UK
had the fourth-highest total household
debt in the world at £1.8tn. People are
being offered buy-to-let solutions as a
retirement investment choice, without
appearing to give careful consideration
to the ramifications of tax, management
fees, upkeep costs and so on. This overreliance on a single asset class suggests
that many need education on the merits
of diversification and impact of high
costs over time.
11 Default Reform: Preventing low incomes with an automatic income plan, The Strategy
Society Centre, March 2015.
12 “Millions of Brits unwisely rely on property to fund retirement warn experts”,The Express,
September 23, 2014.
11.9
MILLION
People have not saved enough retirement
income (DWP estimates)13
13 Featured in “Going for Slow Money”, John Godfrey, Prospect Magazine
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
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2. Poor choices.
The lack of experience of managing
investments and low financial acumen
create uncertainty about the choices
future retirees will make. In particular,
how people will choose among the
three paths of cash, annuity and
income drawdown. The government
provides an impartial and free guidance
service through Pension Wise to
support Generation DC through their
post-retirement plans. However, this
service is not in itself able to solve
some profound issues, such as lack
of engagement or interest, or lack of
financial literacy. Laura Myers, Partner
at the actuarial consultancy Lane Clark
& Peacock, says: “The shock budget
announcement made everybody in the
industry consider what retirees will do
going forward. There has been a lot of
concern about people taking cash and
maybe blowing it all or taking drawdown
and not being able to manage it.”
3. Uncertainty about
member behaviour and
demographics.
Retirement patterns today are in a state
of flux. Working full-time and retiring at
state pension age is no longer the norm;
the new norm has become a retirement
journey where we work longer or
part-time. There is even considerable
uncertainty about longevity. People
routinely underestimate how long they
will live.
“There are millions of people affected, so there
will be some who indeed make the wrong
choices. That is inevitable.”
Paul Trickett
Independent Chair of L&G Mastertrust
17%
Today, only a minority of people say that
working full-time and then stopping work
altogether would be the best way for them
to retire.14
The L&G Mastertrust’s Paul Trickett is
sanguine about the changes: “We’re
going to be hit over the next few years
by a stream of popular outcries. For
instance, politicians will indulge in
chest-beating that people have made
the wrong choices. There are millions of
people affected, so there will be some
who indeed make the wrong choices.
That is inevitable.”
These instances need not hold back
progress, asserts Mr Trickett, provided
trustees and the industry address
14 “New figures show retirement is changing”, Department for Work and Pensions, January 2015.
them: “I don’t think that many people
understand mortgage products, but
they’re able to cope with getting one and
buying a house. Nobody understands car
leasing, but millions of people lease a car.
So people can cope with these products.
But the quality of the communication and
the service we as trustees and providers
show to members must increase. We are
old-fashioned in the way that we do that
at the moment.”
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
9
CONCLUSION
Following the introduction of the pension reforms in April 2015,
the financial services industry experienced a huge upswing
in calls about the new freedoms. The Association of British
Insurers reported that in the week following the pension
changes, its members handled a total of 229,932 phone calls
from customers asking about their choices. This represented a
massive 214% increase in expected average call volume. The
association’s members also received more than 10,000 written
and email requests. This was twice the normal average.
15
Pensions freedom day:
The front-line experience
SOS
229,932
PHONE CALLS
from customers asking about their choices,
in the week following the pension changes.15
On 6 April 2015, the starting gun was
fired on pension freedoms. According
to Keith Stoneham, Head of DC
Customer Service at Legal & General,
call volumes at Legal & General’s
DC-based contact centre were up
25 to 30% in the days following the
changes.
One of the early emerging trends has
been savers with smaller pots who
are interested in accessing cash.
“The experience we have seen, and
this is probably no surprise, is people
considering taking cash lump sums,”
says Stoneham. “Given the smaller
fund sizes in question, they’re not
going to be overly affected by the
tax implications of that, or the annual
allowance implications either. I think
what we’re seeing is the pent-up
demand of people going, ‘Right,
I’m going to cash in’. They’re not
necessarily looking at the longer
term.”
He does highlight, however, that
15 “57,000 calls a day on pension reform”,The Daily Telegraph, 15 Apr 2015.
it is important to treat these
developments carefully and to not
rush to categorise them as definitive
indicators. First, there is a difference
between the numbers of people
making these sorts of enquiries and
those actually moving to concrete
action. Second, it is impossible to
understand savers’ wider financial
picture. For example, retirees
accessing DC savings as cash could
have legacy DB schemes that will
provide their long-term security.
Mr Stoneham says, “It’s too early
to assess the impact of people
cashing in their small pots. There’s
the possibility that they have other
pots elsewhere - larger pots where
they’ve been saving for a longer time.
So, with this smaller pot they’ve had
since 2012, they’re just using this
cash for something now, and they
might well have other arrangements
in place.”
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
10
The intensity of interest in the pension freedoms, after years
of apathy, is a telling illustration of the size of the task ahead for
trustees. For trustees and their investment partners, responding
to the challenges of this radically different landscape will require
significant innovation in scheme design. In the near term, schemes
will be making any immediate changes required to governance,
investment strategy and immediate communications about the
changes. In the longer term, however, we believe that leading
pension schemes will innovate in two areas:
• Investment strategy.
There is an exciting opportunity to rethink
investment strategies at critical stages:
pre-retirement and post-retirement.
We are already seeing innovative new
solutions and thinking in pre-retirement
funds, the use of multi-asset funds and
target-date funds, the development of
specific retirement-income funds, and
the emergence of a second-generation
annuity. Trust-based schemes are also
thinking about post-retirement solutions,
from providing access to individual advice
to offering drawdown within the trust.
• Digital platforms to
improve communication
and engagement.
Schemes and providers have a
significant opportunity to build a much
richer understanding of their members
and create tailored communications and
guidance – using digital channels and
platforms – that truly engage. This will
be particularly critical for post-retirement
planning, and managing the risk that
retirees using drawdown strategies run
out of money too early.
Responding to the
challenges of this
radically different
landscape will require
significant innovation
in scheme design.
GENERATION DC
ISSUE 1: DELIVERING THE PROMISE OF PENSION FREEDOMS
With greater freedom and choice
comes greater responsibility. Retirees
face greater responsibility for their
futures. Schemes and their trustees
face greater responsibility in enabling
the best outcome for their members.
Schemes will need to work closely with
investment management firms to build
creative new investment solutions.
Communications will need to embrace
21st century media to change the
member experience and encourage
engagement and understanding.
Innovation is essential to deliver the
retirement dreams of Generation DC.
Retirees face greater
responsibility for their
futures.
11
Delivering the UK’s brave new
DC world: success factors
• The government’s guidance service Pension Wise will
need to work and it will need to cover a lot of bases. People’s
circumstances change, so they will need advice at different stages
of their retirement journey.
• Education will be needed to raise the UK’s levels of financial
acumen about inflation, diversification and the implications of
member choices before and during retirement.
• Communications need to embrace the digital world, to become
more customised, accessible and tailored for members.
• More research and understanding is required into member
behaviour in a post-budget world.
• A robust default fund must be in place for those who
‘do nothing’.
Plotting a route for lifetime savings
FROM: Product Innovation
TO: Communication & Guidance
• Pre-retirement funds
• Tailored communications
• Retirement income
• Digital channels
• Second-generation annuity
• Drawdown risk awareness
• Post-retirement solutions
• Education
In two forthcoming complementary articles, you will find our views on the implications for default
strategies and investment choices, and how leading schemes can transform their member experience.
Important Notice
Views and opinions expressed herein are as at July 2015 and may change based on market and other conditions. This document is designed for
our corporate clients and for the use of professional advisers and agents of Legal & General. No responsibility can be accepted by Legal & General
Investment Management or contributors as a result of articles contained in this publication. Specific advice should be taken when dealing with
specific situations; investment decisions should be based on a person’s own goals, time horizon and tolerance for risk. The information contained
in this document is not intended to be , nor should be, construed as investment advice, nor deemed suitable to meet the needs of the investor. All
investments are subject to risk.
© 2015 Legal & General Investment Management Limited. All rights reserved. No part of this publication may be reproduced or transmitted in any
form or by any means, including photocopying and recording, without the written permission of the publishers.
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