DWP published paper on possible 'defined amibition' schemes

hyubh

The Department of Work and Pensions have put out an interesting paper on suggestions for what it terms 'defined ambition' pension schemes, in between traditional DB and DC ones. The Telegraph is splashing on it, though as usual, the newspaper write-up is pretty rubbish. The actual paper is here:

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/255541/reshaping-workplace-pensions-for-future-generations.pdf

Key points:

• Proposes to encourage existing private sector DB schemes to continue by liberalising the law for future accurals, in particular removing the requirement to inflation proof pensions.
• Connected to the last point, advocates allowing existing DB schemes to abolish deferred pensions going forward - i.e., if an employee leaves before scheme retirement age, then require them to transfer out to a DC fund.
• Also suggests allowing (and encouraging?) DB schemes to adjust their normal pension age to reflect motality rates; one should think in terms of funding the number of years likely a scheme member will likely be retired rather than a fixed retirement age.
• However, statutory protections should be in place for anyone within 10 years of their existing NPA.
• The paper goes on to summarise various 'DC+' schemes (my term!) found in other countries.
• While in general the paper advocates liberalising pensions legislation, it does suggest member communication requirements for 'DA' schemes should be tougher in law.

Quite an interesting (and reasonable) read I thought...

jamesd

I'd call them DC- schemes.

They seem to share the same general disadvantage as RPI annuity purchase: you lose around half of your potential retirement income to get guarantees that only matter in the unlikely cases. But instead of giving you the choice at retirement, you have to lock into it during the accumulation phase.

You can protect for those unlikely cases with existing drawdown-related options like:

1. Cash pool of 1-5 years of investment income so you can draw on this rather than capital during a downturn, particularly the tough case of a big drop just after retiring. This sort of approach is described at in the research paper mentioned by Wade Pfau at http://wpfau.blogspot.co.uk/2013/10/cash-reserves-in-retirement.html , with the paper itself in the September 2013 Journal of Financial Planning, "The Benefits of a Cash Reserve Strategy in Retirement Distribution Planning," and is by Shaun Pfeiffer, John Salter, and Harold Evensky.

2. Purchase of options or covered warrants. Again to protect against big drops at particularly sensitive times like the first few years, or smaller drops at less sensitive times. These are already large existing protection markets.

3. Being flexible on income. If you don't halve your income at the start by buying an RPI annuity you can cut back to closer to that level as required to maintain a sustainable income level. You don't also lock yourself into the bad result income level if good things happen when you do this.

4. Not discouraging mortgage lending into retirement. Current practice tends to have mortgage end limits at the highest stress time for someone retiring before state pension age: just before the state pensions start. The investment risks are lower, and prudent income higher, if the pension ends ten years or so after state pension age, because the state pension is then providing an income boost and floor that makes payoff more affordable. If not familiar with this effect, try adjusting the mortgage payoff time for an interest only mortgage in Firecalc and seeing what happens to the very high success rate safe income level.

As with annuities, it looks as the proposal is to lock pension investors into the bad result income case, even if the good things happen.

If a government wants to protect me, use those existing methods rather than requiring handing over large chunks of potential income to insurers. Packaged properly they do the job and don't require creating yet another class of pension.

hyubh

jamesd wrote: »

I'd call them DC- schemes.

Possibly, but removing legal barriers, other things being equal, would be a good thing, right...? (I confess I was/am more interested in the 'DB-' side mind.)

They seem to share the same general disadvantage as RPI annuity purchase: you lose around half of your potential retirement income to get guarantees that only matter in the unlikely cases.

Presumably there's research been done on this to quantify 'unlikely' in the way a lay person could follow...?

4. Not discouraging mortgage lending into retirement. Current practice tends to have mortgage end limits at the highest stress time for someone retiring before state pension age: just before the state pensions start. The investment risks are lower, and prudent income higher, if the pension ends ten years or so after state pension age, because the state pension is then providing an income boost and floor that makes payoff more affordable.

Hmm.... so the government (somehow) should be encouraging further personal indebtedness? Or are you saying there are legal barriers for lenders here that should be removed? For me those are two quite different things.

If a government wants to protect me, use those existing methods rather than requiring handing over large chunks of potential income to insurers.

I didn't read the paper as suggesting government 'require' much beyond better communication... or did I read it wrong?

Packaged properly they do the job and don't require creating yet another class of pension.

To be fair, your suggestions as a package are rather complex and technical too...

kidmugsy

Sorry: I had written a comment here, quite forgetting my intention not to comment until dunstonh's return.

jamesd

hyubh wrote: »

Possibly, but removing legal barriers, other things being equal, would be a good thing, right...?

Not sure about that. It appears from the document that a key target market may be those who have low incomes and who are using auto-enrolment. That's not a group that needs to have their potential retirement incomes reduced any further.

hyubh wrote: »

(I confess I was/am more interested in the 'DB-' side mind.)

I haven't read much of that portion yet. It initially appears to be trying to salvage something that in the private sector has already been effectively eliminated for new employees. Bit late to salvage that so, without having read much of it, I'm wondering if it'll just compromise the existing schemes before they run to their natural ends.

hyubh wrote: »

Presumably there's research been done on this to quantify 'unlikely' in the way a lay person could follow...?

Have a look at Firecalc and its ilk. Those use past performance to test whether a plan would have survived a broad range of market conditions or work out what income can be taken while surviving them without failing, or with a specified chance of failing. Such tools are intended for consumer use, helping them to understand the failure risk from varying investment conditions and come up with plans that survive it.

hyubh wrote: »

Hmm.... so the government (somehow) should be encouraging further personal indebtedness?

I'm assuming that there will be a mortgage anyway and considering the lowest risk time to clear it.

hyubh wrote: »

Or are you saying there are legal barriers for lenders here that should be removed?

Not legal but regulatory. The FSA and now FCA have effectively been discouraging lending into retirement and that harms the finances of retirees because of the poor timing.

The best way to see this sort of thing is to start to experiment with Firecalc or similar tools and adjust the timings. What you'll find is that the potential minimum income level in the worst cases is higher when the repayment is delayed until later in retirement.

hyubh wrote: »

For me those are two quite different things.

Agreed.

hyubh wrote: »

I didn't read the paper as suggesting government 'require' much beyond better communication... or did I read it wrong?

The proposed products require that for those using them. Since the proposed products are to be for workplace DC the employees could easily be left with a take the lower income or opt out, lose the employer contribution and get forced to have a lower income that way instead choice. That's something I want to avoid.

hyubh wrote: »

To be fair, your suggestions as a package are rather complex and technical too...

Some parts are - not many are familiar with options and covered warrants. Something as simple as money in a savings account is pretty easy to understand and the study found that just one year of investment income in a savings account increased the success rate of one case from about 60% to 66%. Same sort of simplicity for taking less income if your capital drops substantially for a sustained period. Pretty easy to understand that and it dramatically increases the chance of success for the pot sizes that aren't already so large they always succeed.

For those doing DC planning there's lots of interesting material at Wade Pfau's blog and I'm grateful to FatherAbraham for pointing me to it. If you wonder why I had some focus on market drops in the first years of retirement this post about sequence risk may help to explain it. Nothing really new in that post, just a nice illustration of it compared to some. Though the Firecalc home page graph of three fates with the same amount of money and just different retirement dates is also interesting.

njm123

The title of the paper says it all "Reshaping Workplace pensions for future generations" - anyone who is part way through their working life won't have the time to recover the loses they'll make on what they expect when this kicks in (It's a done deal - it's only a matter of which extra bits to protect employers get added.). Anyone who is in a defined benefit scheme may as well assume they will get zero pension as there are provisions suggested that allow companies to transfer these to the new scheme, and so transfer all your benefits to a defined contribution scheme when you change jobs. For example when the employer makes you redundant because you are too expensive for them.


"


49. We do, however, want to support employers, scheme trustees and members who, properly advised, wish to alter the shape of past accruals through options that already exist, such as incentive transfer exercises and changes made with member consent. Such options are legitimate ways for employers to manage their risks as long as they are well run in line with best practice. "


The problem with this that it's a collective "Members", and so long as you shape the question/vote right it's easy to get a majority - i.e. Assure retired members their rights are protected and then ask if past contributions of active members should move to the new scheme, and setting the vote up so the company votes by proxy for those who don't.


I'd have more faith that 'We're all in it together' if


a) Honouring existing commitments was set in stone so that whatever planning people have done in good faith is not just thrown out leaving them to rely on benefits.


b) MPs and public workers were getting the same treatment, but I don't see Steve Webb suggesting his pension should go to defined contribution when he's voted out of office or given a peerage.

hyubh

njm123 wrote: »

Anyone who is in a defined benefit scheme may as well assume they will get zero pension

That sort of hyperbole doesn't help anyone. If you have a defined benefit pension, public or private sector, then the fact remains you are likely to be in a far better position pension-wise than most other people who don't.

as there are provisions suggested that allow companies to transfer these to the new scheme, and so transfer all your benefits to a defined contribution scheme when you change jobs.

Yes, that's the getting rid of deferred pensions I highlighted. I'm a bit sceptical of that given it's normal to move from job to job over a working life, though I can see it follows from removing indexation in payment.

The problem with this that it's a collective "Members"

The problem is a general apathy and DB scheme members not realising how good things are for them!

b) MPs and public workers were getting the same treatment,

Well the discussion of scheme pension ages in the paper at least very much relates to the changes in public sector DB schemes going on.

jamesd

The pension ages were one of the things that troubled me in the DC section. For at least some of that work they used a lower life expectancy than today's male cohort life expectancy for those who have reached age 65. That would boost the claimed benefits by understating how long they had to be paid out for.