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The UK’s Chancellor took the insurance world by surprise in March when he effectively abolished defined contribution (DC) fund members’ need to annuitise.
New rules will allow DC members to draw down, annuitise, or cash in their pension pots from the age of 55. The result? The populist press praising the liberation of the public’s savings—and a third being wiped off the share price of some annuity providers. Ouch.
As share prices recover, pension funds and providers are rethinking their lifecycle strategies. Currently, lifecycle strategies are the default option for most, and they are nearly always geared towards members targeting annuitisation at retirement. Now there are other choices: how will the construction of lifecycle funds be affected?
“The Chancellor’s reforms may result in a change of destination for the majority of members, and such an alteration will need to be taken into account in the design of future lifestyle strategies,” says Morten Nilsson, CEO of NOW: Pensions. The company confirmed it is reviewing the structure of its funds to ensure they are suitable for this new environment.
Lifecycle products will now have to evolve to target different aims: “For some members, we’ll be targeting a single lump sum, so we could see lifecycles that focus on cash,” says Towers Watson’s Senior DC Consultant Will Aitken. “But for many people, they’ll be targeting a long-term income stream and possibly even an annuity purchase at a far later date than we’ve traditionally seen. This may be the end of one-size-fits-all lifecycles, not lifecycles themselves,” he adds.
“We’ll increasingly see some sort of pot-size division, where part of the pot is de-risked to cash, and the rest to something with duration and probably investment risk,” Aitken continues. “Most members taking drawdown will take advice and not rely on the default, so the amount of risk at retirement will only be moderately more than now.”
Tim Banks, managing director of the pension strategy group at AllianceBernstein, argues that the presumption that individuals will retire on a specific day and immediately annuitise on retirement, will become a redundant concept.
“Target-date funds’ [TDFs’] investment strategies recognise that members may prefer to keep their funds invested while they decide what to do with them,” Banks says. “As a result, we expect TDFs to continue increasing in popularity as the default strategy of choice.”
But Nigel Aston, head of UK DC at State Street Global Advisors, believes the industry will need to go beyond offering decent TDFs. “Workplace savers crave the security of income that annuities provide, but with the access flexibility that drawdown products offer,” he says. “The industry must now create innovative products that intuitively blend these customer aspirations.”
And Laith Khalaf, head of corporate research at savings provider Hargreaves Lansdown, also warns that the days of the default fund could be numbered.
“Default funds work on the basis of what the average employee can be expected to do. Until now, that meant buying an annuity for 90% of pension savers. From now on there are any number of pension withdrawal options,” he says. “Default funds have always been a blunt tool, but investing in one of these now looks like trying to eat a steak with a spoon.”