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Saving for retirement can take over 40 years, so it is naturally a vulnerable process.
In the lead-up to retirement, there are plenty of risks that play out over an elongated timeframe: under-saving, under-investing, and the now-more-topical risk of drawdown use.
Throughout the journey, there is the ever-present danger of investment scams. The government and its regulators - the Financial Conduct Authority (FCA), and the Pensions Regulator (TPR) – are tasked with minimising these risks and creating an environment in which people can grow a pool of savings that will generate sufficient income for the retirement they wish to lead.
RIP DB
But perhaps the biggest risk is a lack of security. A declining number of people are members of traditional defined benefit (DB) schemes, which provide a guaranteed retirement income and, certainly, few people outside of the civil service and public sector are still accruing benefits in such systems.
The value of these schemes to their members in terms of a guaranteed secure retirement income has led regulators to tighten up the rules around financial advice in respect of people swapping their security for a cash lump sum.
Ensuring that people fully understand what they are giving up has been a huge challenge, so there is not only the risk to their financial security that policy makers must manage, but a so-called "education" risk that they be tempted to do so in the first place. In some cases it will be the right thing to do, but the FCA has been at pains to point out that those scenarios will be the minority.
Most non-public sector employees are responsible for building their own defined contribution pool of savings and a major risk is that of not saving enough over their working lives.
This risk has been mitigated in part by the introduction of auto-enrolment in 2012 and has seen the proportion of employees saving into a retirement plan grow from less than 50% then to around 80% now.
While this is a huge step forward, risks remain because employees earning less than £10,000 are not auto-enrolled, while everyone else has the chance to opt-out of their plan.
Further, the rules require a minimum of 8% of participants' "band earnings" to be invested, which in and of itself is unlikely to be sufficient to generate a full replacement income.
The FCA and TPR are wielding various tactics on three broad fronts.
Firstly, to increase consumer awareness and engagement with their retirement savings, consumers have access to free advice from the government’s Pensions Wise service and are receiving "wake-up" packs and more nudges from the age of 50.
Secondly, the regulators want to raise the levels of advice and guidance available to consumers. The new Consumer Duty takes effect at the end of July, and expressly requires firms to act to deliver good outcomes for retail customers.
Thirdly, more responsibilities, as well as flexibilities, are being applied to firms managing people's retirement savings: increased governance obligations, including undertaking annual value-for-money assessments to ensure their products are offering the value they intended; and flexibilities such as more potential to invest in infrastructure and other longer-term and lower liquidity investments.
Dashboard Delay
Perhaps the most personalised engagement tool is that of a Pension Dashboard.
In an age where more people change jobs more often throughout their careers, it is easy to amass multiple different pension plans and equally easy to lose track of them or to pay duplicative charges. These risks could be mitigated by a dashboard summary of all the pension plans of which an individual is a member. However, due to start rolling out later this year, the government has unfortunately recently announced a further delay to its launch.
Lastly, when retirement approaches, there are hugely important decisions to be made about how best to use accrued pension savings.
The choices multiplied when pension freedoms were introduced in 2015.In one fell swoop the requirement to use pension savings to buy an income annuity disappeared.
While that option remains, people now have options ranging from accessing all their savings as cash, to remaining invested and drawing down income directly as they need it.
With those decisions come big implications for personal taxation, income levels (both now and to keep up with inflation over time), and the sustainability of pension savings over the course of a lifetime.
To mitigate one of the regulators concern in this regard, the FCA requires firms serving unadvised consumers to elect an investment "pathway" defining how the savings they access will be invested in the future to avoid them being left predominantly in cash with consequent value-erosion from inflation.
Andy Petit is director of policy research at Morningstar
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