On the run up to Pensions Freedom Day the focus has been on “how many members will transfer from a Defined Benefit (DB) Scheme to a Defined Contribution (DC) Scheme” or “how many members will take their full fund as a one off cash sum”. That day has now come and gone and it’s time to start focusing on the future for DC members.
Prior to the 2014 budget, members of DC arrangements could take 25% of their pot tax free on retirement and use the remaining pot to buy an annuity. The majority of members (up to 80%) did not consciously make any investment decisions and their funds were fully invested in the default fund. Members simply left the default fund to do the rest and hope for the best when they reached retirement.
Default funds are a mandatory requirement where an employer is using the scheme for automatic enrolment. The majority of DC members will end up in the default fund either due to choosing to do so or by automatic default. The default fund will normally have a lifestyling option built into this. As the member moves closer to the nominated retirement date (usually 65) the investment mix of the pension fund is moved from equities into bonds and cash to avoid short term fluctuations in the fund value.
With the changes that came in on Pension Freedom Day, default funds with lifestyling may not be the best option for a lot of the members. As members approach their nominated retirement date they may wish to defer taking their fund as cash until a later date or draw funds throughout their retirement. Therefore these members may need to leave the accumulated fund in riskier assets for longer therefore making lifestyling funds unsuitable.
Trustees and/or sponsoring employers will need to review their default funds, if not already doing so and establish if there are better alternatives out there better suited to their members. Trustees and/or employers should regularly review their default option, especially over the coming months as new options develop in the market as a result of Pension Freedom Day. It should be noted that, following these changes, some providers are behind on providing suitable products with some providers holding off until they see how members react.
The next step is to communicate these changes to members. There are minimum communication requirements set out by the Pensions Regulator (tPR) which includes letting members know what their options will be when they reach age 55, along with details of Pension Wise. This is unlikely to be enough to get members engaged with their DC pension and how these changes will impact on their investments.
With all the options now available to members when they come to retire, thinking about retirement and investments now is imperative. Members will need to start thinking about:
1) How they will want to take their fund at retirement. Take it all as cash; buy an annuity or a mixture of both?
2) When will they retire. Age 55, 65 or when they receive the state pension?
3) Are the investment choices what they want and/or are they contributing enough?
It may be time for the Trustee and/or employers to review their communication strategy and establish if there are better ways to engage employees regarding their pensions and ensure that they have the right knowledge in order to make decisions regarding their current pension investment strategy and also their future in retirement.