Auto-enrolment has helped fuel the rise of defined contribution pensions. How have the ways in which employers deliver these schemes to employees evolved?
There has been a significant shift from group personal pensions and trust-based pension schemes towards master trusts after regulation made the former more onerous. Multiple non-connected employers use the same master trust environment and it’s a completely outsourced service. Even the governance is outsourced to third-party trustees, so there’s no decision-making by employers other than which master trust they use. They just pay across their contributions. A couple of years back there were probably about 100 master trusts, which The Pensions Regulator said was too many, and some weren’t particularly well run, so it introduced an authorisation process. This not only reduced the market to around 30 master trusts, but also ensured employers and pension scheme members can receive a very professional service with good protections.
How does the experience of retiring through a defined contribution scheme contrast to that of a more traditional defined benefit scheme?
It’s much more complicated, which will be highlighted in the next five or ten years when the first people with only defined contribution benefits to rely on reach retirement. With defined benefit schemes, you get what you are given. There is no flexibility, but a lot of certainty. With defined contribution, you have to make the decisions about how you take your benefits yourself. There is a lot more freedom about what you do with your pension pot, but also risk that you might run out of money earlier than had you not had those freedoms. You have to think about how long you are going to live, how much money is in your pot, how much should you draw from it each month or quarter, how long that will last and where to invest your pension to provide a sustainable retirement income. They’re really difficult, complex decisions and most people don’t have the knowledge or experience to work it out for themselves. The risk brings uncertainty and uncertainty can bring inertia. Indeed, the biggest action we’ve seen people take at retirement, in the first few years since pension freedoms were introduced, is no action.
The biggest action we’ve seen people take at retirement…is no action
What is required to protect members and ensure they are using pension freedoms to their advantage rather than disadvantage?
Put simply, technology. And we’ve been on our own journey in recent years to help simplify and improve the whole defined contribution experience for pension scheme members. We started with modelling tools, whereby you put in the pension values you have collected from different places through your working life, along with your preferences and risk level, and it calculates your income potential. But we realised we need to do more.
What technology specifically enabled you to take a more sophisticated approach?
Open banking. We developed an open banking app that sits alongside our master trust and, if you want to use it to its fullest extent, you link it to your bank accounts to aggregate not only your income but your expenditure too. The app builds a picture, over a period of time, showing the income you need to sustain your life. Giving somebody that kind of intelligence, in an engaging mobile app, is much better than asking them what they think they will need, which most people struggle to answer. We’re delivering to members the answers we always wanted them to put into the modelling tools, but were never certain they would take the time to do. By taking the information capture element out of their hands, we can seamlessly deliver valuable insights on how much income they need against their pension, what we think they need to draw down each month and what age it will last them until. It has been a really useful step forward.
How do you intend to simplify people’s retirement journey even further?
In the past, you have always had to send an instruction to your pension provider saying you want to draw down, say, £1,000 a month, which is paid until you say you want a different amount or you want to stop it or you die and the benefits are passed onto those who survive you. We don’t know whether members are drawing too much or too little, so we think there’s a better way. Using the information that’s in that open banking app, we can set a rule that says you don’t want the balance in a bank account to fall below the amount that covers all your essential outgoings. Every time it then looks like it’s going to fall below that amount, the app sends a message saying you need to draw a little bit more from your pension scheme. Not only do you only draw down the amount of money you actually need to provide for yourself, but it also means you won’t find yourself in the sudden position where you forget there’s an insurance premium or a tax bill that needs to be paid and there isn’t enough money in your bank account to cover it. Of course, we also know a lot of people suffer from cognitive decline with age, which adds to the complexities of making financial decisions, so we think the app can take some of those difficulties away, avoiding unnecessary risk or distress.
How do you see the pension landscape playing out in the coming years?
There is a big wave of people that arrived into the defined contribution pensions environment in 2012 as part of auto-enrolment and who may already be coming up to retirement now. We are taking all the knowledge we gained from being part of the defined benefit environment and we are trying to build it for individuals in a defined contribution space, with the added bonus of pension freedoms. That’s the kind of experience that the defined contribution generation will get, which is completely different from the experience those who have already gone through retirement received over the last five or ten years. It’ll be a world apart and ultimately it is technology led.
For more information please visit seic.com/en-gb/solutions/master-trust
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