What’s been happening and what’s on the horizon in the world of pensions?
With the inexorable rise of defined contribution (DC) and the progressive shift in focus by policymakers towards DC decumulation, this edition of Pensions Watch examines the PPI’s recent research findings into DC decumulation policies across the globe and asks what lessons the UK can learn from the eight pension systems covered.1 Spoiler alert – it isn’t a simple copy and paste.
Decumulation decision making is difficult
Defined contribution (DC) decumulation has been described, by Nobel prize winning economist Bill Sharpe as, “the nastiest, hardest problem in finance”. And for good reason. Striking a balance between meeting current and largely unknown future needs, not least given the vagaries of longevity and health longevity, is indeed a knotty problem. Moreover, given worries about future financial security, health, later life care and leaving an adequate bequest, moving from a deep-seated lifetime-of saving mindset to a spending frame, by drawing on an exhaustible, nonreplenishing pot of money, demands a fundamental psychological shift of mindset. Consequently, when given a choice of how to utilise their DC pension pots, many retirees are reluctant to draw down their pension assets – many simply withdraw the income generated – thereby compromising their retirement living standards, often dramatically so.2 Of course, at the other end of the spectrum, there are those who operate a myopic approach to retirement spending, resulting in them outliving their retirement savings, sometimes very prematurely.3
So, whether outliving retirement savings or living in penury in fear of doing so, the risk of individuals sleepwalking into a suboptimal retirement is ever-present. Quite the problem then and unquestionably a growing policy issue.4
The UK experience
In the UK, prior to the 2015 freedom and choice reforms, most DC savers were required to annuitise their DC pots at retirement to provide a lifetime income. This accorded with the fundamental mantra of the OECD and the Mercer CFA Global Pensions Index,5 that the primary objective of any pension system is to ultimately generate a secure and sustainable income stream in retirement.6 However, post-freedom and choice, despite the ever-greater dependence on DC provision in retirement, the multitude of largely unquantifiable investment, economic and demographic risks which need to be managed and the difficult choices that need to be made, the decision-making process continues to be largely unsupported by the provision of accessible frames of reference, guidance and low-cost advice. This, coupled with the almost total absence of financial education, especially from an early age, means that even the simplest of calculations or concepts are largely unfathomable to most people.
Consequently, most people simply don’t know what’s feasible and realistic at and in retirement.7 Moreover, this enormous decision-making burden, which weighs heavily on the shoulders of a largely ill-equipped, disengaged and rapidly ageing population, with a deeply entrenched preservation mindset, comes at a stage in peoples’ lives when financial literacy and cognitive ability often starts to decline. Couple all of this with retirement increasingly being phased, rather than a one-off event with a well-defined destination point, that demands a solution which offers both security and flexibility, and you definitely have “the nastiest, hardest problem in finance” to grapple with and ultimately resolve. The question, of course, is how.
Addressing the decumulation challenge
Given these challenges, the PPI recently published its findings into the decumulation experience of eight DC pension systems, comprising those in the US, Canada, Australia, New Zealand, the Netherlands, Denmark, Singapore and Chile, to see what policy measures applied to the management and drawing down of DC pension assets might improve UK retirement outcomes. These range from guided choices, to setting minimum drawdown rates, to partial and full compulsion to annuitise DC pension pots.8 Of course, applying lessons from one country to another isn’t a simple copy and paste, given the UK’s and these comparator countries’ unique features, not least the role and quantum of the state pension, how the second and third pillars are expected to interact with this first pillar, all against often very different societal and demographic backdrops and tax and social security frameworks.9
What can the UK learn from the decumulation experiences of other DC pension systems?
Despite these often stark differences, lessons can certainly be learnt by the UK from what has and hasn’t worked elsewhere. Listed below are the key takeaways from the PPI report, how the UK is currently positioned on each of these points and how it could be positioned if better DC outcomes are to become the norm.
1. The inherent flexibility of DC offers ample opportunity for policy to accommodate the ever-increasing phasing of retirements and individuals’ ever-changing needs and circumstances in retirement. However, no one pension system has yet fully squared the DC decumulation circle by adequately addressing the multiple risks and changed circumstances individuals must navigate throughout their retirement.
Not having fully developed policy in this area, the UK is in the enviable position of being able to do so based on the experiences of its peers.
2. Having a minimum pension income underpin, courtesy of a simple, trusted, index-linked state pension, results in higher gross replacement rates and provides an element of longevity insurance. However, in some countries, rather than being universally applied, the state pension is means tested, as in Australia, whereas in others, e.g. Canada, it is both universally applied and means tested, or completely absent, as in Singapore.10
Although applied universally in the UK, the full new state pension, despite the unique triple lock, fares poorly against most of its international peers in gross replacement rate terms, so cannot be relied upon to provide anything other than a minimum standard of living in retirement. If the state pension isn’t to form the mainstay of UK retirement outcomes, as some predict it will, then a more prescriptive policy on decumulation must be formulated.
3. Minimum drawdown provisions, which prima facie strive to move retirees from a preservation to a consumption mindset unintentionally create de facto defaults, or anchors.11 12 However, to be effective, these provisions must be designed around a consensus of what a good outcome looks like and shouldn’t be implemented principally and explicitly to recoup income tax deferred in the tax-incentivised savings phase. To do so simply compounds retiree resentment around the loss of control of their savings.13 Minimum drawdown provisions, as implemented, also largely fail to address the inclination by many to save and not spend these compulsory withdrawals. This growing policy challenge is where good guidance and/ or well-constructed defaults come into play. More on each of these shortly.
While UK policy doesn’t currently provide for a minimum drawdown rate, this warrants serious consideration, notwithstanding the policy shortcomings identified in the report. After all, while acknowledging that retirement spending in many countries historically tends to fall in real terms, especially in later retirement,14 in the UK the demographic bulge of aspirational “sandwich generation” second wave baby boomers (now in their late-50s to early-60s) and early Generation Xers (now in their late-40s to mid-50s)15 will likely be the first whose financial commitments and real spending could well increase, not decrease, throughout retirement.16 A policy which fails to overcome this preservation mindset will not serve this capacious generation of retirees well.
4. So to guidance. Placing simple, accessible, trusted, timely, well signposted and behaviourally robust17 guidance – think rules of thumb, on-line expenditure calculators and drawdown modellers – at the centre of decumulation policy and delivering this in a consistent way,18 to support individual decision making, can lead to desired behaviours, such as overcoming the reluctance to draw down pension assets sustainably to support a realistic standard of living in retirement. However, once again, if guidance is to materially improve outcomes through regular engagement, the imperative must be to first define what a good outcome looks like and – given life’s twists and turns – to ensure the guidance is regularly revisited. Otherwise, an optimal retirement path is unlikely to be followed.
Guidance in the UK principally comprises two relatively well signposted free-to-access information sources in Pension Wise and the Pensions and Lifetime Savings Association’s (PLSA) Retirement Living Standards (RLS). Pension Wise, the free-to-access telephone and face-to-face- based generic pensions guidance service for those aged 50+ has, by approaching an ultimately complex decision via logical and well framed questioning within a series of simple steps, helped many achieve better retirement outcomes.19
However, one-off generic guidance from Pension Wise, typically at the point of retirement, is unlikely to be sufficient, given that peoples’ circumstances and spending patterns change throughout retirement, sometimes markedly so. Therefore, as noted above, this aspect of guidance should be applied repeatedly to ensure an optimal path is continually followed. Meanwhile, the PLSA’s RLS, via simple, accessible and relatable single number anchors, helpfully illustrate what life in retirement might look like for both a single retiree and a couple, either living in or outside of London, at three different levels of spending: minimum, moderate and comfortable.20 Anchoring those who are metaphorically all at sea to a single relatable expenditure number is incredibly powerful. Moreover, later in 2026 this guidance will be supplemented by the long-anticipated launch of the pensions dashboard, which will allow individuals to view all of their pensions information, including the state pension, together in one secure place.21
However, much more could be done – along the comprehensive lines of Australia’s Retirement Income Covenant and the New Zealand Actuaries Retirement Income Interest Group’s (RIIG) Rules of Thumb22 – in helping those at and in retirement to gauge what is reasonable and realistic.23 Indeed, in the latter case, the idea is to help retirees to choose withdrawal rates in an informed manner, based on their retirement needs and preferences. That said, many commentators have suggested that no amount of guidance can substitute for advice.24
5. There is a strong case for segmenting retirement income policy between low earners, those on a middle income and high earners.25 In the UK, as the full state pension provides a high replacement rate for those on a below median working life income, any accumulated pension savings are best employed as a capital buffer for contingencies and to meet large one-off expenditures. At the other extreme, those with a high working life income are the least likely to require high replacement rates in retirement and be the most likely to seek regulated advice in exercising freedom and choice.
However, those with a middle working life income will likely be the cohort to most rely on their DC pension pots to supplement the state pension if replacement rates, hence retirement living standards, are not to be unduly compromised. Therefore, it is this cohort on which UK decumulation policy should principally focus.
6. Investment, inflation and longevity risk, which most individuals would prefer not to bear unilaterally or manage individually in retirement for reasons of complexity and cost, can be pooled via employer and industry group structures in a cost-effective way to dramatically improve outcomes.26 That said, there has been a lukewarm take up of innovative lifetime income solutions, which manage some or all of these risks, in some other countries.27
Although the UK doesn’t offer a mechanism to pool these risks, serious consideration is being given to the introduction of decumulation-only Collective Defined Contribution (CDC) funds which would pool all three risks in a cost-effective manner, although possibly at the expense of retirement income levels being cut periodically.
7. Major policy reform is often best enacted via timely public debate, social partnerships (comprising policymakers, employers, unions and members) and proactive regulatory action, as exemplified by the Netherlands.
Policy in the UK is enacted typically after industry consultation though without public debate, with regulation often being reactive, rather than proactive. As the PPI report notes, “consultation and regulation should stay ahead of the market to ensure that consumers are properly informed and protected against new or unexpected risks.”28
8. Retirement income, hence outcomes, can be compromised, sometimes significantly so, if funds saved for retirement are explicitly made available for other purposes, such as housing and medical costs.29
Although UK DC pension pots are not formally segmented for particular expenditures in decumulation, leakage can occur by allowing full or partial cash lump sums withdrawals, so compromising retirement income streams. That said, this flexibility is valued by many in decumulation but can result in the premature depletion of DC pension pots.
9. Although housing wealth is a key asset for many at retirement, in most countries, bar Singapore, housing assets typically play a minor role in satisfying retirement income needs, despite far exceeding the value of other financial assets held outside of retirement asset pots.
Indeed, in the UK, equity withdrawal from owner occupied housing is used sparingly as a means to supplement retirement income.30
Some concluding points
In addition to the above takeaways, there are several concluding points to be made in light of the PPI report’s findings and how these might be applied to potentially ease the challenges faced by those in the UK who are increasingly reliant on their DC pension pots at and in retirement.
Firstly, a general point. As societies age, so a disproportionate amount of collective wealth will increasingly be held in pension and other assets which will support retirement spending. How these assets are distributed across populations and the extent to which these assets are draw down will not only have a marked effect on individuals’ standard of living in retirement but on economies’ fortunes and on intergenerational and generational wealth and income inequality. While policymakers around the world are becoming increasingly alert to this, they have yet to fully square the circle on DC decumulation, not least in ensuring the majority of middle-income earners, with appropriate guidance, voluntarily draw down at a sufficient rate to ensure at least a modest income in retirement. This is a challenge UK policymakers should be increasingly cognisant of in formulating policy.
Secondly, two UK-specific points. As noted earlier, over the next two decades we will not only see a marked increase in the proportion of a growing population adopting a phased retirement and reaching State Pension age, but also a generation that will likely be the most long-lived in history and whose financial commitments are likely to increase throughout retirement. As this will coincide with an increasing reliance on DC pension pots to support a desired standard of living in retirement, if left unsupported the consequences of individuals making a wrong decision at and in retirement will rise exponentially over time.
So where to from here for UK decumulation policy?
With yields normalising, for some, still likely the minority, annuitisation may now seem to be the answer to guaranteeing income security, at least in nominal terms, thereby avoiding the early depletion of pension pots and the risk of living too frugally in fear of the latter.31 Whereas for others, likely the majority, the solution that most closely meets their needs, demands both income security and flexibility, i.e. income drawdown. The problem is, of course, that income drawdown, which must prospectively underpin a desired standard of living that might extend to 30+ years, must sidestep the worst effects of investment sequencing risk, especially early in the decumulation journey, unexpected inflation and, often vastly underestimated, longevity risk. Of course, annuities and drawdown are not mutually exclusive and can be complementary – as evidenced in some of the pension systems considered by the PPI report.
However, the crux of the issue, as noted earlier, is that most people simply do not know what is feasible and realistic at and in retirement. As a result, to reinforce yet another point made earlier, many are at risk of sleepwalking into poor active and passive decisions and landing in a very bad place. Many already have. Consequently, and perhaps unsurprisingly, it was noted earlier that the contention of many prominent pension practitioners and commentators post-pension freedom and choice is that, regardless of the quantity and quality of guidance provided, most people will never truly engage with the complex decisions to be made at and in retirement. Nor will they ever have the confidence and capability to select and successfully manage the retirement solution that most closely meets their needs.
Leading on from this, three additional points are increasingly being made. The first is that a collectivist solution – one that pools the largely unquantifiable risks, noted earlier, that accompany flexibility in decumulation – trumps an individualist retail-type solution. Indeed, the latter can prove sub optimal and costly, in both absolute and opportunity cost terms, not least given the lack of shopping around and advice being taken in the UK prior to purchase. Consequently, decumulation only CDC, while not yet a reality in the UK, already has a core band of supporters. The second is that the success of automatic enrolment in the accumulation stage of DC is testament to the power of harnessing the inertia of the disengaged by opting eligible employees into pension saving and so should be replicated in decumulation. The third is the legendary power of the default. In pensions, as in all aspects of life, the default option is that which is overwhelmingly selected.
A potential solution …
Therefore, for a largely unsupported and unadvised mass market, principally comprising middle-income earners seeking to supplement the state pension, to underpin a desired standard of living that might extend to 30+ years, the solution prospectively lies in an auto-enrolled, well-governed, behaviourally robust, appropriately charge capped, institutionally-managed DC, or CDC, decumulation default, which combines income security with appropriate flexibilities. These flexibilities could comprise an option to finesse the default’s key defined parameters at set times, within certain tolerances, to meet individual preferences – contingent on the flexing of the other features, the individual’s age and the size of the remaining pot. Ad hoc cash withdrawals to meet one-off expenditures or contingencies would also need to be accommodated, again within set tolerances.
Opt-out provisions could be made available to those who are better able and willing to make their own decisions and create their own bespoke decumulation solution, notably higher earners with less need for high replacement rates. Of course, both opt outs and flexibilities should only be enacted with regulated advice.
Crucially, to support a desired standard of living with no nasty surprises, any solution would need to be underpinned by an investment medium which obviates the threats to the preservation of capital, noted earlier, and an ability to sustainably generate a real stream of income to meet budgeted spending. This could be supplemented by a minimum income guarantee underpin, to support a well thought through mandated minimum rate of drawdown, along with longevity insurance, the latter provided courtesy of a deferred annuity.32
Not that this suggested solution is breaking new ground. Indeed, as the PPI report notes, “Three national actuarial bodies of the US, UK and Australia have jointly concluded that there would be value in developing appropriate defaults that allow individuals to access their pensions through an income stream that offers flexibility on their early years of retirement. However, in the latter years, they could provide, at a minimum, a structured lifetime payment with a potential for a lifetime income guarantee to protect against their longevity risk. [Moreover] previous global reviews have recommended that defaults to hybrid or multiple retirement income solutions are needed for DC pensions to balance flexibility with protection.”33
But what if…?
However, if a collective auto enrolled default isn’t regarded by policymakers as the solution, then there’s no getting away from the fact that people will need to be properly supported throughout the retirement planning, implementation process and retirement journey – with all of its twists and turns. People will need to have their options, choices and potential outcomes explained and illustrated to them in a simple, clear, understandable, relevant and practical manner, and be assisted by the more widespread provision and signposting of accessible and behaviourally robust tools, guidance and, crucially, advice. That’s quite a resource-heavy ask but a necessary one.
Why does this matter?
To end on a blunt note, ultimately whether a minimum, moderate or comfortable retirement in the UK becomes the norm, is largely contingent on timely and decisive action or continued inaction by both the pensions industry and policymakers. To yet again reinforce the points made earlier, over the next two decades we will not only see a marked increase in the proportion of a growing population adopting a phased retirement and reaching State Pension age, but also a generation that will likely be the most long-lived in history and whose financial commitments will most probably increase throughout retirement. In coinciding with an increasing reliance, principally by middle-income earners, on DC pension pots to support a desired standard of living in retirement, if left unsupported the consequences of making a wrong decision at and in retirement will rise exponentially over time.
Thankfully, despite the marked differences between the UK and the PPI report’s comparator countries, there are lessons to be learnt and practices that merit further investigation by UK policymakers, providers and practitioners. In fact, the UK is at an inflection point, in that there is the potential – indeed a unique opportunity – to demonstrate pre-eminence in decumulation policy if the best is taken from what the rest of the world has to offer. More specifically, if policymakers, providers and practitioners can agree on appropriate defaults, a suite of good guidance and advice more broadly, then it’s reasonable to expect that this could unlock better investment strategies and culminate in better retirement outcomes. However, timely intervention is needed if the potentially significant, if not catastrophic, economic and societal risks that could result from continued inaction are to be avoided. In short, the clock is ticking.
