By Steve Charlton
Every country’s pension provision seeks to solve the same problem. And yet, every country’s solution to that problem is unique.
At Vanguard, we’ve learnt a number of lessons from different markets offering defined contribution (DC) pensions around the world. These markets have each taken different approaches. The successes of each approach provide insight to what we could do to help DC scheme members in the UK reach their retirement goals.
It may sound strange, but one of the main lessons we’ve learnt is to build the end at the beginning. This means focusing as much time and resource thinking about the income stage as on designing the accumulation stage of a pension scheme. Just as we develop schemes that help members accumulate sufficient assets for retirement, we need to also design products or services that will deliver good outcomes in the income stage of retirement.
The income phase is in the spotlight since the recent pension freedoms were introduced. As it stands, this phase is still being finessed even in countries where DC is well established such as the US and Australia. And no one has come up with an ideal income solution yet.
This is an additional layer of responsibility for trustees, employers and scheme providers. But there is also a lesson here for legislators and regulators. They need to understand the effect their rules can have on product development and member behaviour, especially whether certain taxes act as an incentive or disincentive.
In Australia, for example, the government sees a role for annuity-type products as part of a comprehensive income product in retirement. But annuities are unpopular because receiving income from one affects social security payments. Another insight from an Australian study into lump-sum withdrawals found many people are being far too cautious. Those with account balances greater than AU$50,000 don’t want to run down their savings, viewing it as part of an inheritance for the next generation.
A further key lesson is the need for good scheme design and education. Good scheme design refers to the use of defaults or automatic features that help steer members to better outcomes. Features such as auto enrolment and auto escalation have helped improve participation and savings rates in the US, Australia and more recently in the UK.
We can learn a lot from the success of target date funds (TDFs) in the US. Selecting TDFs as the default option is a good example of how a scheme can improve member outcomes. Our research in the US shows that, in aggregate, the use of TDFs leads to better diversified portfolios and better investment outcomes compared with investors who make their own investment decisions.
Thoughtfully designed defaults – such as TDFs – make sense, especially for those without the knowledge, interest or time to asset allocate, rebalance and trade in portfolios. These barriers to achieving good investment outcomes are eliminated with TDFs. The complex investment decisions become the responsibility of experienced investment professionals.
Our task is to develop design features to encourage good outcomes in the retirement income phase too.
Along with good scheme design, we also need educational resources so members know what their options are and how to decide between them. This could be web-based tools, which we see in the US, that illustrate how different savings and asset choices will affect how much accumulates or how different spending patterns in retirement affect the pot.
As an industry, our challenge is to build on the progress we have made in the UK with auto features and the new pension freedoms. Learning from the evolving DC markets around the world, we believe DC pension schemes can be designed to mitigate negative outcomes and promote positive outcomes for members, scheme providers and society as a whole.
Steve Charlton is DC proposition manager at Vanguard Europe
