A Parliamentary committee has proposed a ‘default investment pathway’ for people who don’t make active pension choices at retirement. But should the government be making it easier for people to ignore their most important retirement decisions?
Many people are currently receiving poor value from their pension products, according to a report by the Work and Pensions Committee. Despite the freedom to access their pension pots in a variety of different ways, a significant number of pensioners are making inappropriate choices, such as picking funds with high management fees. The report finds that this is largely down to a lack of knowledge about the options available, and limited awareness surrounding pensions in general.
The Committee has proposed, as a possible remedy, that all pension providers offer a default option for customers who make no active decision about their pensions. This ‘default investment pathway’ would be a drawdown fund with management fees capped at a low level (0.75 per cent has been proposed). If the proposal is accepted, these ‘default pathways’ could be available from April 2019.
Currently, some pensioners may be losing over £12,000 in management fees by unwittingly choosing the most expensive drawdown funds or providers. This new scheme certainly has the potential to save some people money – but is it really the best way to address the problem?
The limitations of a default option
The new proposal is intended to protect individuals who are not sufficiently engaged with their pension to understand their choices. However, any default investment option is likely to provide, at best, only a moderately satisfactory outcome for the person concerned, and could itself be very poor compared to what else might be available. In short, for many pensioners it would be a ‘least worst’ option, purely by virtue of having low fees.
Former pensions minister Sir Steve Webb, now policy director at Royal London, has criticised the proposal as being ‘against the spirit’ of pension freedom. He points out that a provider cannot suggest the best option for a saver without having information about their other assets. More broadly, there is a risk that savers will place too much faith in the default option, and that the existence of it will encourage apathy around pension-related decisions. Some may begin to assume that they no longer have to take an interest, since their pension will sort itself out automatically.
If people aren’t engaged, they should be
The reality is that pension decisions can make a huge difference to income over the course of a typical retirement. Many people remain unaware of this fact, due to the lack of engagement cited by the Committee. But such an attitude could prove very costly in the long term. Someone with an average-sized pension pot might end up tens of thousands of pounds worse off over 20 or 30 years, compared to what might have been by making some informed decisions about how to invest and draw their pension pot. And this is before factoring in other risks, such as the danger of drawing out too much money at the wrong time, depleting the drawdown fund and eventually exhausting it.
This raises another key point: the moment of accessing a pension is not the only critical choice that a person may face. A default pension option might appear to ‘solve’ one problem (high fees), but other problems (such as how to avoid running out of money) will remain. Allowing people to sidestep advice at the first important choice may only be storing up bigger problems for later.
In short, to accept that people are ‘not engaged’ with their pensions looks rather like a cop-out. If someone says they are not interested in their pension, they are essentially saying they aren’t interested in what they’re going to live on for the last quarter of their life. If people aren’t interested, they need to become interested; and if they don’t understand, they should find someone they can trust who will explain it to them.
To shepherd people into a low-cost, low-benefit fund just because they don’t have enough information is surely doing things the wrong way round. Rather, people need to have that information, in an accessible form they can’t easily ignore. They should also be encouraged at every opportunity to think about their income in retirement, how much they’ve saved and how much they might need, and how to achieve their goals via their choices. Widespread active engagement should be the ‘default option’ – with everyone thinking as hard about their pension as they once did about their first job.
You can lead a horse to water…
The Committee’s proposal is well-meaning and probably necessary; some people may never engage with their pension, and so will need a fall-back option to kick in if they fail to take action. But ideally, such individuals should be in a small minority. Pension choices made at the point of retirement are some of life’s biggest decisions – at least as significant as buying a first home. Most people will not want such decisions being made for them, and will want to be involved in the process and understand it.
Pension freedom was introduced in 2015 to give savers precisely this kind of control. The old saying may apply here: that you can lead a horse to water but you can’t make it drink. But although there may need to be a fall-back option for those who won’t engage with their pensions, there is much more to be gained by educating people, enthusing them about their retirement choices, and encouraging them to try the fresh waters of pension freedom.
This article was previously published by Unbiased on 9th April 2018