BAE Systems brings in new default to target drawdown

The trustees have made this new option the default. They have also introduced white-labelling to the scheme’s self-select fund range to cut down on the work and cost involved when making changes.

A communication to members shows the updates went live in the first quarter of this year. 

I would strongly recommend any trustees that don’t have white labels to really consider it

Laura Myers, LCP

Previously, the two lifestyle investment profiles on offer included a cash option for members expecting to use up to 25 per cent of their DC pot for a tax-free cash lump sum and the rest to buy an annuity at retirement. This was the default option for the BAE scheme.

The other lifestyle option was for members who expected to use all of their DC pot to buy an annuity at retirement. 

Given the introduction of pension freedoms, “the trustee has decided to replace the two current LIPs with three new LIPs… the Flexible LIP, the Annuity LIP and the Cash LIP”, the update states.

The third new option “aims to provide an investment portfolio at retirement, which, relative to the alternative LIPs, should be more appropriate for members moving their DC pot into an income drawdown arrangement”, it adds.

This option uses a growth fund, a multi-asset fund, a bond fund and an inflation-linked government bond fund. 

According to the trustee update, changes have been made to the underlying funds in the new annuity and cash lifestyle profiles.

The new Cash LIP uses five funds, including a growth fund investing in equities, a multi-asset fund, a bond fund, an inflation-linked government bond fund and a money market fund. Previously, it used a growth fund, a ‘transition fund’, a mixed bond fund and a deposit and treasury fund. 

Before the changes, the annuity-targeting LIP used a growth fund, a transition fund and an annuity fund. 

As a result of the DC overhaul, the new annuity-targeting LIP uses six funds. These include a growth fund, a multi-asset fund, a bond fund, an inflation-linked government bond fund, a money market fund and an annuity purchase fund, which invests in corporate and government bonds. 

Schemes continue to adapt to pension freedoms

Since freedom and choice was introduced, lots of DC schemes have adapted their strategies to give members more flexibility. 

Laura Myers, partner and head of DC at consultancy Lane Clark & Peacock, notes that generally – prior to freedom and choice – schemes either had one investment strategy targeting annuities as a lifestyle strategy, or sometimes several lifestyle strategies all targeting annuities and often having different levels of risk for the growth phase.

“Typically, if [schemes] had more than one lifestyle strategy pre-freedom and choice, it was about risk levels,” Ms Myers says. But since 2015, most pension plans have “stripped away the risk-profiling” and are focusing instead on the members’ end point, in terms of what they are targeting. 

Thirty per cent of schemes surveyed by LCP in a 2018 survey said their default investment strategy targets drawdown, while 22 per cent target annuities, 15 per cent target cash and 33 per cent target all three.

Similarly, a Willis Towers Watson FTSE 350 scheme survey showed that the number of schemes targeting income drawdown at retirement has risen threefold, from 11 per cent of trust-based schemes in 2017 to 30 per cent in 2018. 

Pensions Expert reported last year that the Mitchells & Butlers pension scheme had updated its default strategy to target drawdown purchase,

“It’s how you think the majority of members are going to end up taking benefits, and I still don’t think that we’re going to see members taking regular drawdown for a considerable while,” says Mark Futcher, partner and head of DC and workplace wealth at Barnett Waddingham.

Generally, savers still have small DC pots, which would struggle to give them a generous income every year until they die. 

“But they might take larger lump sums from their DC pot over the next five, six or 10 years – so it’s more of that ‘lumpy-type’ drawdown,” Mr Futcher notes. 

If a trustee board decides to switch the default to target drawdown, they will have to think carefully about how they deal with members closer to retirement.

For members in the final three to five years of the glide path, “if it was targeting annuities previously, they’ve already likely started switching heavily into bonds and gilts – switching them back into a drawdown kind of lifestyle will ‘re-risk’ them. You’ve got to think, is that appropriate?”, says Mr Futcher.

This often means that schemes ringfence these members, and change the future glide path for everyone else, he adds. 

White-labelling can improve efficiency

The trustees of the BAE Systems DC scheme have also introduced white-labelled funds to its self-select fund range. 

“At present, making changes to the self-select fund range involves a significant amount of work and cost. Having taken advice on possible ways to simplify matters, the trustee has decided to introduce the concept of white-labelled funds, which is already used by many other UK DC pension schemes,” the scheme update states.  

The Visa Europe Pension Plan made a similar move last year when the trustees chose to use white-labelled funds, which do not reference the underlying investment management companies. 

Doing so enables trustees to make changes to the overall fund without seeking member consent every time. 

“Where companies have committed to running their own trust-based scheme, white-labelling tends to be the way to go,” says Mr Futcher. 

Trustees can make changes more easily, they do not necessarily have to explain to members the individual changes to the fund or fund managers that they wish to make, he notes. 

“They just describe the general nature of the fund, and as long as the components are still within that remit and those kind of parameters, they’re allowed to make those changes,” he says. 

Lots of companies have decided that they do not wish to run their own trust-based scheme and have switched to bundled arrangements or master trusts instead. 

“That’s where we tend to see them favouring the off-the-shelf selections, rather than creating their own, to try to reduce the risk and the governance burden that they’re taking,” Mr Futcher notes. 

Ms Myers is a strong advocate of white-labelling in DC. “From a member’s perspective, it’s much easier to explain,” she says. 

From the point of view of the trustees, “as long as it fits within the white-labelled fund name and description, if you wish to change a manager you can do that quite simply”, Ms Myers adds.

She warns that, without white labels, it is possible to accidentally create unintentional defaults when moving members from one fund to another. 

If a manager is underperforming and the trustee wants to replace them with a different manager, if the fund is not white-labelled, members have to be moved without their consent. The arrangement would then fall under the definition of a default, which is subject to charge controls. 

“I would strongly recommend any trustees that don’t have white labels to really consider it,” Ms Myers adds.