Defined contribution pension schemes: half of savers have no idea how to access their pot

The IFS report, funded by the IFS Retirement Savings Consortium and the Economic and Social Research Council, looked at the importance of defined contribution schemes and their role in financing retirement plans.

It looked at how people planned to use the pensions freedoms introduced in 2015 and what plans they had to access their saving; in 2015 the requirement to buy an annuity was scrapped and people over the age of 55 with defined contribution (DC) pension pots were allowed to decide what they want to do with their funds.

When asked how they planned to access their pension pots, more than four in ten of those in their 50s and early 60s with defined contribution pension pots answered ‘don’t know’. The report also found not having a plan for how to access pension pots in retirement was even more common among those with low levels of wealth and those who have not used a financial adviser.

Size of DC pension pots

The report warned: "Such large numbers not knowing how they will access their pension is worrying. People find it too difficult to engage with, and plan for, their financial security in retirement even as they approach retirement.

"These are important decisions: half of people in their 50s have defined contribution pension pots. As the prevalence and size of average DC pots continue growing, due to automatic enrolment and the decline of traditional defined benefit pensions, future generations will be increasingly reliant on DC schemes for financing their retirement. These decisions will be more consequential for each subsequent generation."

Making pension withdrawals 

Most of those who accessed their DC pension plans for the first time withdrew their pot in full, and the report expressed concerns that people might be spending their retirement resources too quickly. The report added: "However, even fully withdrawn pension pots typically make up a small fraction of overall resources – on average (at the median), the withdrawn funds account for only three per cent of private family wealth."

There was "an important minority of people who make large withdrawals from their pension pots that constitute a large fraction of their total financial resources. For one in six of those who withdrew a DC pot in full, the amount withdrawn was worth at least £20,000 and this amounted to at least a tenth of their overall family wealth. This is the group where making good decisions around accessing their DC pension pot will be particularly important for their living standards through retirement."

Heidi Karjalainen, a research economist at IFS and an author of the report, said for older scheme members accessing their savings was a "low stakes decision": She added: "But that will change as future generations will rely more heavily on defined contribution pension pots for financing their retirement."

She said financial advice and support was a priority: "Developing how best to support people to make good financial decisions when accessing defined contribution schemes is crucial, so that individuals are protected against adverse outcomes through their retirement."

Generation X

The IFS report found DC pension wealth had increased significantly and the the demise of DB pensions in the private sector and the introduction of automatic enrolment into workplace pensions meant just under half of those in their mid 40s, so born in the mid 1970s, had some savings in a DC pension plan.

This compared with 37 per cent of people born in the mid 1960s at the same age. Younger age groups are also less likely to be actively saving in a DB pension scheme than current older workers.

People in their 50s with higher levels of overall wealth also tend to have greater amounts of DC pension wealth while those with levels of wealth typically have so little accumulated DC pension wealth that however they withdraw it, it is unlikely to make a meaningful difference to their standard of living over the course of their retirement.

"On the other hand, people with very high levels of wealth tend to also have significant amounts of other wealth available to support them in retirement."

Sleepwalking into retirement

The report added it was those around the middle or the upper middle of the wealth distribution for whom the decisions over how to access private pension wealth were going to be most consequential and the key decision will be the extent to which people want to trade off flexibility - by withdrawing chunks of cash or using ‘flexi-access drawdown’ -  against the security and certainty provided by an annuity.

Phil Brown, director of policy at People’s Partnership, provider of The People’s Pension, said: “We welcome the findings of the IFS research, which resonates with our longitudinal study, New Choices, Big Decisions, which shows that many savers are sleepwalking into retirement.

"This is further evidence for why policy makers must require pension schemes to guide members to products which match retirement risks, including living longer than they had planned for, and which will ensure that defined contribution pension savers have an income throughout their retirement. The industry must end the assumption that every saver has the required knowledge to navigate complex decisions about their retirement savings.”