The UK government’s decision last week to push down the age at which workers can automatically be enrolled in a company pension scheme was widely praised. It is great news — given the power of compounding on long-term savings, the earlier people get going, the better.
But with that decision out of the way it is time for the government to look at the other end of the pensions market and tackle what Nobel Prize-winning economist William Sharpe has called the “nastiest, hardest problem in finance” — the question of decumulation, or how to plan savings and spending in retirement.
Most people never had to think much about this. In a world of defined benefit pensions, employers provided ex-employees with regular pension payments and all the hard work was done by scheme actuaries and investment managers.
That world is on its way out. In the new era of defined contribution pensions, individuals retire with a pot of pension savings and then have to deal with tough questions about how long they might live, what care they might need in older age, what inflation might be 20 years into the future, and more. In short, everybody has to become an actuary.
Worryingly, most people are tackling these thorny questions with no advice or guidance at all. According to research from the Social Market Foundation and insurance group Phoenix, only a fifth of those aged 50-64 have spoken to a financial adviser about their pension. And only 14 per cent of people accessing a defined contribution pension pot for the first time seek guidance from the government’s Pension Wise service, which offers free appointments to the over-50s.
This creates major risks. The biggest is that people could underestimate how long they might live, spend too much in early retirement and then run out of money at just the moment when they need to pay for care in later life. But there is also an opposite risk, argues David Sinclair of the International Longevity Centre, that people are too cautious: “One of the reasons we’re concerned is that a lot of people under consume and that has a massive impact on the economy.”
It is a problem that needs some sort of intervention. “It can’t just be left to the market,” says pensions expert John Ralfe. “It needs to come from the government.”
Parliament’s Work and Pensions Committee has dug into the issue and last year came up with a range of recommendations. These include a trial of automatic Pension Wise appointments and a clear goal for the combined use of Pension Wise and paid-for advice when accessing pension pots for the first time.
They are sensible ideas but the government’s response has been lukewarm. “We do not believe that it is appropriate to set a target figure for Pension Wise uptake,” it said in its response to the committee. “We also do not support the trial of a system by which members are automatically booked a Pension Wise appointment,” it added, citing concerns about costs and the potential for inappropriate guidance. Instead, the government prefers giving a “strong nudge” to people to look for support.
But skimping on advice and guidance could prove a false economy for the government. The costs of inadequate retirement planning are huge, both for individuals and for the public purse. If retirees run out of money the state will end up bearing some of the costs.
This is a challenge that will only grow. The generation of workers with defined benefit pensions is being replaced by one with defined contribution arrangements. And society is ageing. There is the potential for a slow-motion pensions crisis in the coming decades unless action is taken now to help people make some of the trickiest financial decisions they are ever likely to face.