Budget 2014: How historic DC changes affect your scheme

Traditional strategies have focused on moving investments though a variety of increasingly defensive assets towards the target of purchasing an annuity at retirement.

Defined contribution scheme managers and trustees have seen their default investment strategies rendered “not fit for purpose” by last week’s historic Budget changes, which have fundamentally changed the run-up to retirement for workplace savers.

“All of that is totally blown out of the water,” said Laith Khalaf, head of corporate research at investment platform provider Hargreaves Lansdown. “People are going to be invested in equities for longer, people are going to have all sorts of needs in retirement they are looking to address.”

In Australia, of the people who retired at age 65 with a lump sum, only 4 per cent purchased an immediate annuity, according to a 2013 report by the country’s Treasury. George Osborne’s Budget announcement saw providers’ share prices fall as the market took stock of the changes.

Will Aitken, senior DC consultant at Towers Watson, said it was an issue for most defaults, which currently target annuity purchase, adding: “Our current view [is] that is not going to be fit for purpose in the new world.”

He urged DC schemes to talk to their membership to find out what they are planning in retirement, and design strategies to fit. “We need to talk to our members and find out what they are planning to do,” Aitken said.

Damian Stancombe, head of employee benefits at consultancy Barnett Waddingham, said the traditional lifestyle strategy was “gone, gone, gone”.

Schemes should consider revising decumulation strategies so they can be split to meet the “myriad” retirement targets from income drawdown, cash lump sum and annuity, he said. “You can’t do it through a default fund,” Stancombe added.

The chancellor announced that from April 2015, full withdrawal from DC at retirement – apart from the 25 per cent tax-free lump sum – will be taxed at marginal income rates rather than the current 55 per cent.

Under changes to trivial commutation rules, members will be able to take small pension pots worth up to £10,000 as a lump sum at retirement, up from £2,000, for up to three pension schemes.

“I still think that a lot of people will still choose to get an annuity because a lot won’t want to take the risk of drawdown,” said James Auty, head of JLT’s annuity bureau.

The capped drawdown limit will be raised to 150 per cent from 120 per cent, which the government hopes will give greater flexibility to those who would otherwise buy an annuity.

The amount of guaranteed pension income people need in retirement to access their savings will also drop to £12,000 from £20,000.

It was also announced members of DC schemes will be offered “free and impartial face-to-face guidance on their choices at the point of retirement”.

“To deliver this, the government will introduce a new duty on pension providers and trust-based schemes,” the Budget stated.

Richard Butcher, managing director at professional trustee company PTL, raised concerns about the ability of trustees to secure this for members by the deadline of April next year.

“Where are the people that are going to be giving them this guidance?” he said. “It is an infrastructure that does not exist.”

He added there was “a theme of inconsistency” in the government’s policy by increasing workplace saving while reducing the barriers to wasting cash at retirement. He said: “Offering people cash does not seem to me to be consistent with security.”

Paul Macro, head of DC at consultancy Mercer, said employers need to “keep a keen eye” on members that will be retiring between now and when the reforms come into effect, as they will be in a “state of limbo”.

“If the flexibility is as it seems to be, most people are going to wait until next April to do something,” Macro said.

“Employers with DC schemes need to be thinking very clearly about what happens when people get to retirement… We could have some quick examples of that for reasons no one predicted.”

The changes will have the upside of reducing the attractiveness of pension liberation scams, which promise early access to pension pots but incur large tax charges.

It was also announced that from March 20 HM Revenue & Customs would be given broader powers to prevent such fraud with greater control to register and deregister schemes.

Switching pension pots

The government also announced plans to remove the option for those in public sector defined benefit schemes to transfer into a DC scheme, on worries DC saving could become more popular.

There were concerns that large numbers of people might seek to leave their DB scheme to improve their retirement choices, creating strain on the taxpayer to cover the cost of the unfunded schemes.

“Depending on what the rules are, I think people would want to transfer from a final salary DB scheme if they could get their whole pension as a lump sum,” said Khalaf.

Some experts believe that greater flexibility at retirement may lead to significant changes in the products offered to retirees, as they seek more tailored strategies.

“One thing we’ll see is people taking cash and buying deferred annuities,” said Ed Wilson, pensions director at consultancy PwC. “The changes allow people to manage themselves but also allow the financial services industry to provide a wider range of products.”

Wilson said there was higher risk for members in taking control of their own affairs, but that the increased saving into DC could lead to overall larger pots, mitigating that risk.

This story was updated on March 21 at 16:33