In recent years, the conversation around defined contribution (DC) pensions has gained momentum, especially in light of significant regulatory changes and the challenges faced by individuals as they enter the retirement phase. The Pension Schemes Bill (the Bill), set to introduce key reforms to the decumulation phase of DC occupational pension schemes, promises to reshape how DC members access and manage their pension pots in retirement.
The decumulation phase refers to the period when pension scheme members begin to access their savings to provide income during retirement. Unlike the accumulation phase, where workers contribute to their pensions, decumulation focuses on how retirees can ensure their money lasts through their later years. With the rise of DC schemes as a result of auto-enrolment, many members are now tasked with making important decisions on how to turn their pension pots into sustainable income, yet many lack the support and guidance to make well-informed choices.
What to expect from the Bill
The Bill seeks to address several key factors that are considered by the Department for Work and Pensions (DWP) essential for improving member outcomes in retirement. We understand from both the response to the July 2023 Consultation and the Mansions House 2024 Speech that the focus is on enhancing engagement, providing better support and guidance, and offering more tailored decumulation solutions. Below are the key proposals expected in the Bill.
Active opt-out mechanism
Much like the automatic enrolment system for pension contributions, the DWP intends to proceed with an “active opt-out” provision for the decumulation phase. This means that, even if members do not engage, they will automatically be placed into a default decumulation option unless they choose to opt out or select a different route. This will help address the issue of disengaged members who may otherwise make poor choices or delay decisions until it is too late. However, this will likely put a duty on trustees to offer default decumulation solutions for its members.
The default solution is intended to be tailored by trustees to the general profile of the membership, ensuring that they are placed in an option that is suitable for their retirement needs. While a single default might not work for everyone, it is expected to be a better option than the current status quo, where many members do not receive adequate support.
Trustees’ role and duty to offer default solutions
The Bill is likely to require trustees of DC schemes to take on a proactive role in decumulation. This includes ensuring that suitable default decumulation options are available for members who do not engage or make an active decision. The government’s approach emphasises that trustees should offer these solutions, either in-house or through partnerships with external providers.
Trustees will also be expected to provide clear guidance on decumulation options, helping members understand the various pathways available, such as annuities, drawdown or blended solutions.
Innovative decumulation products
The government has expressed its desire to foster innovation in the decumulation space. This includes encouraging products like Collective Defined Contribution (CDC) schemes, which pool members’ pension pots and provide income in retirement based on collective investment strategies. While these products are still emerging, they could offer a valuable option for members looking for greater stability in their retirement income.
Additionally, we are likely to see new product types combining features of existing solutions. For instance:
- Blended solutions: A combination of annuities and drawdown products could offer both guaranteed income and flexible access to funds, balancing security and adaptability.
- Target-date funds: These funds, which automatically adjust their asset allocation based on the member’s age, could help provide a seamless transition from accumulation to decumulation, offering a more hands-off approach for those who do not want to make active decisions.
Enhanced guidance and education
The DWP emphasises that a critical component of the reforms is the provision of better guidance and support for members. The government acknowledges that many retirees, particularly those without financial advisers, need clearer information to help them navigate the decumulation phase. The Bill is expected to mandate clearer communication, alongside pre-retirement workshops and enhanced online resources, to help members understand their options.
Additionally, personalised tools such as projections of how long their pension pots might last based on different withdrawal strategies and market conditions are likely to be part of the toolkit available to DC members. These tools will help members make informed decisions tailored to their circumstances.
Challenges in the decumulation space
The Bill is likely to bring significant opportunities for improving decumulation options, but it also presents several challenges that must be carefully managed to ensure success. For example, one key challenge is addressing the behavioural barriers retirees face. Many individuals are disengaged from their pensions, often avoiding decisions out of fear of making the wrong choice or inertia. Others may withdraw too aggressively, putting their funds at risk of running out too soon. Additionally, many members lack the financial literacy to navigate complex decumulation options. While default solutions are intended to help disengaged members, clearer communication, personalised guidance and ongoing education, such as pre-retirement workshops and online resources, are essential to empower members to make informed decisions.
On the regulatory front, new decumulation solutions like blended options and CDC schemes must meet FCA and Pensions Regulator standards to ensure they are safe and transparent. Trustees must be cautious not to inadvertently cross into providing investment advice, which would require appropriate exemptions. Balancing innovation with robust regulatory oversight will be critical.
Operationally, trustees will need to offer a broad range of tailored solutions, requiring access to relevant member data and potential partnerships with external providers. Smaller schemes with fewer resources may face operational complexity in implementing and managing these new options. Regular reviews and adjustments to decumulation strategies will be necessary to meet the evolving needs of members. Moreover, the cost of introducing these solutions, alongside the need for ongoing regulatory compliance, could be challenging for some schemes.
Looking ahead
Ultimately, while the Bill promises to enhance decumulation options, successfully navigating the challenges ahead will require collaboration across the sector. The ability to offer default solutions alongside tools for informed decision-making will be key to improving outcomes and ensuring long-term financial security for retirees.
As the Bill progresses, trustees should begin preparing for its impact by reviewing decumulation strategies and considering the increased responsibility of providing default solutions. The DC decumulation landscape is on the cusp of significant change and these reforms offer a promising direction for the future.
For further guidance or if you are interested in discussing how these changes may affect your scheme, please reach out to our Pensions team at Dentons.
