Trust-based and contract defined contribution (DC) pension schemes will need to reconsider the investment options offered and the default investment funds used in light of changes announced in the 2014 Budget. According to Mercer, many DC members will be invested in strategies targeting the purchase of an annuity at retirement. With requirements to purchase an annuity ending from 6 April 2015, existing “life-styling” strategies may now be inappropriate to members’ needs.
According to Brian Henderson, Head of Mercer’s DC & Savings team, “We believe that many people will still buy annuities to provide certainty of income without the need to maintain an investment portfolio in retirement. However, giving consumers more choice on retirement will challenge those who govern DC schemes to consider solutions that meet a wider range of consumers’ needs.
“We are already seeing DC governing boards question the suitability of their investment arrangements in light of the Budget announcement. A key consideration is how to accommodate the fact that not all of the 80% or so of members who invest in a scheme’s default funds will require an annuity when they retire. For example, some will wish to remain invested after their official retirement age and make periodic withdrawals from their pension capital, while others may prefer to withdraw all of their funds as cash.
Mr Henderson added: “Future retirees are likely to have a pattern of expenditure that is ‘U’ shaped. In the earlier years of retirement, expenditure remain high through travel and recreation, then diminishes with age, but will be later replaced by less discretionary items such as medical expenses and long-term care. Experience in other countries, such as Australia; suggest that this pattern will trigger demand for pension schemes that can provide both investment growth and capital stability during retirement. In other words, the most successful DC schemes will be those that not only take people to retirement but have facilities to help members through retirement.”
Commenting on the overall changes, Mr Henderson said, “Giving members more control over how their pension pots are taken will surely enhance the attractiveness of pension schemes and, as a result, boost overall retirement savings. However, these proposals come at a time when other countries are looking at ways to persuade more retirees to purchase annuities in order to avoid running out of funds during their retirement. It’s therefore critical that the ‘right to guidance’ initiative proposed by Government is robust enough to help prevent members taking decisions that they live to regret.”
Notes to editors
From April 2015, the intention is to allow members retiring from a DC scheme to have full flexibility over how they take their account balance. The tax-free lump sum will remain, and any income taken in excess of this is taxed at the individual’s marginal rate of tax i.e. there would be no limit on the amount of taxable cash an individual can choose to take each year. As an interim measure, between 27 March 2014 and 5 April 2015, there is an increase in the amounts that can be trivially commuted, and the drawdown limits are increased. These measures are in effect only temporary for DC schemes given the April 2015 changes. (However, the trivial commutation limits will remain relevant for DB schemes.)
Mercer is a global leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s 20,000 employees are based in 43 countries and the firm operates in more than 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With 55,000 employees worldwide and annual revenue exceeding $12 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting. Follow Mercer on Twitter @MercerInsights |
