With DC assets growing rapidly, Simon Chinnery evaluates three critical factors that can help DC members get over the retirement finish line and retire on a pension that meets their needs

The changing retirement landscape
The ever increasing shift from DB schemes to DC schemes means that the UK pensions landscape is rapidly changing and will continue to evolve significantly over the coming years. However, this changing environment means that many employees may find that the transition from a world of DB certainty to ‘you are on your own’ DC is a bitter pill to swallow. Research into participant behaviour indicates that most people don’t feel they have the ability to decide what to do with their pension and would prefer that their employer ‘do it for them’. DC scheme sponsors will need to navigate these challenges and opportunities as their decisions will shape the retirement outcomes of scheme members for many years to come.

Getting over the finish line
Many scheme sponsors begin by designing their DC schemes based on which type of investment offering may be best for their members. While this is a crucial decision, a scheme’s overall long-term success rate hinges on the interaction of three critical components: how much the member saves (savings), how the funds are invested (investments) and when and how assets are withdrawn (spending).

Assessing plan design from this broader perspective can help significantly enhance overall scheme effectiveness and increase the odds that as many members as possible cross the retirement finish line, safely and securely.

Although these components ultimately remain under member control, sponsors may find themselves reviewing their offerings and how they can influence these components as DC schemes become the main retirement savings vehicle for a growing number of workers. Companies have an opportunity to help place a greater number of members on a more prudent DC path by influencing constructive behaviours through strategic scheme design.

The savings reality
Research recently conducted by J.P. Morgan Asset Management among the British public indicates that half the population is currently saving nothing towards retirement. Auto-enrolment will drive many of these people into some kind of retirement savings vehicle but questions remain about minimum contribution rate levels, which start at 2 per cent and escalate up to 8 per cent, far below the average DB contribution of 21 per cent (1). However, as behavioural research indicates, most people have a tendency to tune out once they have been automatically enrolled into a plan. Plan sponsors need to focus on minimising the number of members who opt out and encourage members to contribute more than the legislative guidelines. Employing proven strategies for increasing member engagement and exploiting behavioural insights will also help members achieve more secure replacement income in retirement.

The evolution of the default
The vast majority of DC members – roughly 85 per cent – are currently invested in default funds, typically balanced or lifestyle funds. This high percentage is good news given that most members lack the knowledge, time or inclination to manage their own retirement assets effectively. However, most of these defaults are based on a lifecycle structure and it’s time to ask whether this will really deliver the best outcome for DC members.

Within lifecycling, the member is rotated, often over relatively few years, out of riskier assets into cash and bonds, in preparation for an annuity purchase. That’s not where the best thinking is now and it isn’t what everyone needs. Lifecycling has served an evolutionary purpose for DC, but it’s typically basic asset allocation philosophy that doesn’t really offer broad enough diversification or a narrowing of the range of possible member outcomes.

We believe target date funds are the next stage in the evolution of the DC default, providing a steadier path to more secure retirement funding. With a series of target date funds, providers can have a greater focus on the needs of a particular cohort nearing retirement, allowing for a range of market conditions and market cycles. Target date funds can offer a greater degree of diversification in terms of asset classes and active professional management, with reduced equity and risk exposure relative to the average lifestyle fund. Defined benefit portfolios generally access a wide range of asset classes, with sophisticated investment strategies so why wouldn’t plan sponsors want their DC members to benefit from that same level of sophistication in the default?

So what happens at the end of the glidepath?
The accepted approach to date has been for plan sponsors to try to maximise average member pots within the plan. However, this may result in many scheme members falling short of the retirement finish line altogether, not being able to pay the bills. Instead, to help more members to achieve a sufficient level of income replacement, it is crucial that sponsors define a target replacement income for the plan as a whole, rather than focus on average account balances.

Currently 95 per cent (2) of members purchase an annuity when they withdraw scheme assets (many before they retire), but rapidly changing legislation and product innovation, as well as relatively low annuity rates, are driving the need for more choice in the future. We are now in a world where retirement ages are being pushed back and we see that increasingly, members will need a more flexible, phased retirement that addresses, for example, a need to continue working part time.

A more secure retirement
With the move to DC, accelerated by auto-enrolment, scheme sponsors face considerable challenges to ensure that members make it to retirement with a minimum level of income replacement. It is therefore vital that scheme sponsors set a realistic and measurable DC goal, develop practical strategies that address real-world member behaviours and provide investments that help members make the most of their retirement assets (with a particular focus on the default offering). We believe that if plan sponsors adopt an outcome-focused approach to scheme design, they can reduce a lot of the uncertainty that often surrounds the DC framework and help members achieve a more secure retirement.

1Source: ONS Pensions Trends Paper2012 Edition
2Source: ABI Research Paper No.23; 2010: Annuity Purchasing Behaviour

Written by Simon Chinnery, head of UK defined contribution, J.P. Morgan Asset Management

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