Invensys changes DC default to target cash

The board has also decided to consolidate the pension scheme’s DC and additional voluntary contributions offering. 

For a reasonably strong member in a DB situation, that’s very likely a good call

Lydia Fearn, Redington

The move makes Invensys a relatively unusual case. Since the introduction of freedom and choice in 2015, many DC plans have updated their defaults to offer members greater flexibility, but only 15 per cent target cash, according to a 2018 survey by LCP.

Twenty-two per cent of schemes target annuities, 30 per cent target drawdown and 33 per cent target all three options, the consultancy found.

As a result of a review last year, the trustee has “changed its default fund to be one that targets cash, rather than an annuity”, the scheme’s latest annual report for the year ending March 2018 states. “This decision was based on an understanding of how members utilise their DC savings,” the report stated.

According to its website, the scheme offers two lifestyle options. The first option is a fund made up of cash and gilts, so is designed for members who wish to take 25 per cent of the fund as cash and use the remaining 75 per cent to buy an annuity.

The second option, which is now the default, results in a fund made up entirely of cash, so would be better suited to those who want to use it as part or all of their tax-free cash sum at retirement.

Following the introduction of pension freedoms, many experts said the dominance of cash withdrawals was to be expected, given that average pot sizes were still relatively small, predicting that it will become less popular as pot sizes increase and defined benefit disappears.

But while it is too early to say whether savers risk running out of money in retirement, some worrying trends have emerged.

As part of the Financial Conduct Authority’s retirement outcomes review, the watchdog found that more than half of consumers were withdrawing their DC pots in full.

Only 25 per cent of these people opted to spend the pot in full, although other disconcerting trends were observed, such as 32 per cent of withdrawals being made into savings accounts exposed to inflation.

Pension Wise, the guidance service now part of the Money and Pension Service, found that among consumers not using its services, 36 per cent of those withdrawing their money used it for discretionary purchases such as a car or a holiday. This dropped to 14 per cent after using the service.

When DB members use DC for tax-free cash

In some cases those taking cash have other sources of retirement income – such as a DB pension pot.

The Invensys scheme’s DC section was closed to further accrual for existing members on March 31 2015, the same date as the DB section.

As at March 31 2018, the scheme had a total of 63,585 members, 182 of which were DC members.

Mark Futcher, partner and head of DC and workplace wealth at consultancy Barnett Waddingham, explains that a scheme may decide to change a DC default to target cash if lots of members have small pots.

But more commonly, Mr Futcher says that cash defaults appear “if this is a DC section of a DB trust, where lots of members are going to use the DC fund to fund their tax-free cash that they’ve built up in a DB scheme”.

He also adds that, while it is often referred to as ‘cash’’ because it is taken as cash, it ends up in an absolute return fund or similar product, so is still keeping pace with inflation.

Lydia Fearn, head of DC and financial wellbeing at consultancy Redington, says: “I am very nervous about putting cash as a target, mainly because other members may not take the money out, so therefore they could potentially have their savings eroded by inflation and, as we know, cash funds struggle to stay above the fees that they charge so there isn’t any room for inflation growth in those funds, and that’s the concern.”

However, if a scheme sees that members are taking their money on the day they say they said they were going to, and on the day that their lifestyle fund comes to an end, then schemes can warrant a decision to target cash.

“Typically we see schemes with some sort of growth in there, even if it’s a moderate level, in order to maintain inflation levels,” she notes.

In terms of targeting cash because of lots of members with small pots, schemes just need to be mindful of what ‘small’ is, according to Ms Fearn.

She agrees that members with a DB pension might decide to access their 25 per cent tax-free cash lump sum through DC, with the remaining 75 per cent staying in DB.

“Because of that [trustees] may well think, ‘Well actually if a member’s going to use it as a tax-free lump sum, that is cash, therefore it should target cash,’ and for a reasonably strong member in a DB situation, that’s very likely a good call,” Ms Fearn notes, adding that “it does depend on what… your membership breadth is like”.

Monitoring member behaviour

A number of schemes updated their defaults within a few years of the introduction of pension freedom reforms in 2015.

Trustees of the Caterpillar Defined Contribution Pension Plan, for example, decided in 2017 to change the scheme’s default fund to target flexible drawdown.

But Mr Futcher says many schemes have waited. “Lots of people realised that they didn’t really know how the new freedoms were going to be adopted by their members or how they were going to be used,” he says.

He adds, those that made an early decision and changed their default soon after freedom and choice was introduced, based their decisions on what the industry expected people to do – “rather than actual hard fact”.

However, Raj Shah, head of DC investment at consultancy Hymans Robertson, says that – in his experience – the majority of schemes updated their defaults in the first two years of freedom and choice.

“Primarily a lot of them moved into cash defaults because they have an existing DB arrangement,” and the DC fund was used for tax-free cash, he adds.

Invensys consolidates AVCs and DC

The Invensys Pension Scheme report also shows that the trustee reviewed the DC and additional voluntary contribution offering that was available to members.

“As a result of this review the trustee has concluded that it should consolidate its offering,” the report states.

Mr Shah says there are a number of reasons why a scheme may decide to do this.

He says AVCs are often held on older platforms set up at the same time as the DB scheme: “The funds and the stuff available – they’re quite expensive,” he says, adding that AVC platforms tend to charge quite a lot, so it is not necessarily good value for money.

“The second thing is the consolidation of the range,” he says, noting there can be lots of fund options for AVCs, which is often a significant governance burden.

Ms Fearn agrees that this form of consolidation often means schemes can get a better price because of the scale, while making governance easier.