DC retirees risk running out of savings without major reforms, warns IFS

The institute has called for major reforms to support people in retirement to draw down from their pots sustainably, as well as expanding access to financial advice and guidance.

The rise of DC as a proportion of people’s retirement savings now means that individuals “face too many complex and risky decisions through retirement”, the IFS said in a new report produced in partnership with Abrdn Financial Fairness Trust.

“This increases the risk many exhaust their private resources and fall back purely on state pensions and benefits, especially later in retirement,” the institute said. “Reforms are needed to make the system easier to navigate successfully in order to help reduce this risk.”

The report acknowledged the government’s push for default retirement solutions, expected to be included in the forthcoming Pension Schemes Bill due later this year.

Some master trusts are exploring how they can provide default retirement options to support savers to take their pensions but without the risk of running out of money. These typically start with flexible drawdown before transitioning to an annuity-like income later in life.

The IFS’s report described these “hybrid” models as a “flex then fix” model, and pointed out that they would help support people as they age – particularly as “cognitive decline” sets in.

However, it warned that these solutions “will not be right for everyone”, such as those with existing defined benefit pensions or those with health issues that affect life expectancy.

Bee Boileau, IFS research economist and co-author of the report, said “key questions remain” over decumulation for DC savers, particularly those who are not best served by defaults.

“The government and pension providers must ensure that it is straightforward to opt out of whatever new defaults are introduced, and that as far as possible those making these decisions are sufficiently informed and helped.”

For this reason, the institute said default options should be “soft” with the ability to opt out at different stages, and providers should offer other options designed to cater for other needs.

Trust-based versus contract-based schemes

The IFS highlighted that the default retirement option referred to by the government in the King’s Speech only applies to trust-based pension schemes. Cotnract-based providers appear to be exempt.

Contract-based pensions – regulated by the Financial Conduct Authority (FCA) – instead have the FCA’s “investment pathways”, introduced to help non-advised customers select a retirement goal.

However, the IFS said it was important to ensure that policy and outcomes were aligned as most DC savers would not understand the difference between contract-based and trust-based arrangements.

The institute suggested that people should be allowed to switch pensions between different types of schemes “at, or close to, retirement”. It also said value for money was a key consideration as few people switch between providers.

Increasing access to financial advice

The IFS also called for the government to make greater access to financial advice or guidance “a policy priority”.

The institute’s research found that around 30% of DC pots worth £250,000 or more were accessed by people who had not used guidance or advice.

The IFS also found that 73% of people in their late 50s with DC pots surveyed between 2021 and 2023 “did not recall using any sort of information about pensions and retirement choices in the last three years”.

“As DC pots grow in absolute size and in relative importance in people’s pension wealth, it will become increasingly important that people have access to help – whether in the form of information, advice, guidance or something in between – in making decisions about accessing and using their money,” the IFS said.

It cited other research that had suggested solutions, including guidance services such as Pensions Wise working more closely with regulated advisers to facilitate full advice for those that need it.

The FCA’s ongoing Advice-Guidance Boundary Review would be an important step in expanding access to advice or guidance for retirement savers, the IFS said. It also suggested that “large language models” – a form of artificial intelligence – could be used in the future to help lower the cost of financial advice.

What the industry said

Ruari Grant, head of DC and master trust policy at the Pensions and Lifetime Savings Association, said: “The IFS is right in its assessment that DC savers need more help managing their pension pots, and so it’s positive that the government is legislating to make sure all schemes provide solutions to enable this.

“All savers have different circumstances and needs, so there is no one-size-fits-all. If schemes can provide high quality defaults while encouraging savers to engage with guidance and consider what products might best suit their individual needs, then that would be real progress.”

Claire Altman, managing director for individual retirement at Standard Life, said government policy was “still playing catch-up” with the impact of pension freedoms a decade ago.

“Those accessing their pensions have a great deal of flexibility and choice but they are also shouldering significant risks when it comes to making their savings last,” Altman said.

She agreed that the “flex then fix” could form part of a solution for many people, citing Standard Life’s own research.

“As the government prepares to legislate for default retirement income solutions, the paper acknowledges that two of the key enablers are a reduction in the number of small pots and increased access to guidance and advice,” Altman added.

“Everyone’s retirement will look different so creating a system that enables people to seek support to maximise their income and one which gives them a comprehensive view of their total savings is critical.”

Supporting savers through retirement

Paul Waters, head of DC markets at Hymans Robertson, said: “Providing DC members with greater protection against longevity risk should be a priority. This can be achieved through DC schemes by building in some form of annuitisation as members get older, or is inherent in the design of collective DC, which also offers this protection.

“Regardless of the design choice, a default approach for members to give them a core path with few tricky decisions should be adopted.”

Waters added that the IFS’s recommendations were considerate of minimising the costs to employers – many of which have already been affected by additional costs emanating from the most recent Budget.

Rob Yuille, head of long-term savings policy at the Association of British Insurers, said retirement decisions were “complex and consequential”, making it important to keep the process “as simple and smooth as possible”.

He also highlighted the FCA’s targeted support plan, which is designed to allow pension providers to provide additional support to certain groups of customers based on the collection of basic personal data.

Yuille continued: “At the same time, the Department for Work and Pensions is introducing guided retirement solutions for occupational pensions – the ‘guided’ element of this is critical, because a one-size-fits-all default won’t work for everyone.”

Kirsty Ross, proposition director at People’s Partnership, provider of The People’s Pension, said her firm’s own research had highlighted how “older savers struggle with the complex decisions ahead of retirement”.

She continued: “One of the reasons why automatic enrolment has been such a success – helping 11 million more people save into a pension – is that it doesn’t require the individual to make ongoing decisions unless they want to. It only makes sense that this support continues through retirement.”