Workplace pensions: Lessons from Down Under.
If auto-enrolment was the hot topic of 2014 and pension freedoms the issue of 2015, 2016 seems set to be the year of the ‘good outcome’, says Gregg McClymont, head of retirement savings at Aberdeen Asset Management
New pension legislation has focused on pulling individuals into workplace pension schemes via auto-enrolment. At the same time, changes to the law have granted greater freedom and flexibility to pension savers.
- How can individuals – and advisers – translate their pension pot into a comfortable retirement income?
- What constitutes a decent retirement income, and how is this best measured?
- Most UK savers are not saving enough to ensure a comfortable retirement
On the issue of workplace pensions, the UK government and regulators have so far focused on getting people saving into defined contribution (DC) schemes, harnessing savers’ inertia via auto-enrolment. While it is vital to lay the right foundations today, it is equally crucial to think ahead. With the government’s pension freedoms giving savers unprecedented flexibility, attention is turning to how best to translate their precious money into comfortable retirements.
But what level of retirement income is ‘good’ exactly? The answer will depend on the saver. And how easy is it to compare performance across the different default funds in which most savers invest, so as to know which are giving savers the biggest boost to retirement pots?
"If the IFS suggests generalising around good outcomes is hard work at the best of times, pensions freedoms have perhaps made the task even more like nailing jelly to the ceiling."
To date, the most commonly accepted way of measuring a ‘good’ retirement outcome is by assessing ‘replacement rates’ – income in retirement as a percentage of a person’s final salary. In 2004, the Pensions Commission set target replacement rates that were widely adopted by both government and industry. These rates start high, for low earners, and taper to a target replacement rate of 50% for those earning over £51,098.
However, research by the Institute for Fiscal Studies (IFS) – Retirement sorted? The adequacy and optimality of wealth among the near retired – questions the Pensions Commission’s replacement rates conclusions. Full cognisance must be taken of the differences between working and retirement – retirees do not face many of the same costs as working people. Retirees, for example, do not have to pay national insurance, provide for children and of course, save for a pension.
More widely, the IFS cautions against the arbitrariness of salary replacement rates – the retirement income one household needs to live comfortably may be very different from another’s even if at first glance their situations appear alike. Living costs, for example, will vary depending on geographical and lifestyle variables such as in which part of the country people live, as well as financial variables, such as housing wealth and other assets. If the IFS suggests generalising around good outcomes is hard work at the best of times, pensions freedoms have perhaps made the task even more like nailing jelly to the ceiling.
A ‘good outcome’ to a 55 or 60-year-old could mean having enough money to pay off their mortgage or debts or fund their children through university, for example. As that same person grows older, however, their idea of a ‘good outcome’ may change and they may regret having spent their savings in early retirement. Whether retirees choose to buy an annuity, go into drawdown or do something else entirely, they will consider this part of their pension savings journey. If their chosen option does not prove good value throughout retirement, it is most likely they will feel they have received a bad outcome.
A dash for dashboards?
In Australia, where DC saving has been compulsory since 1992, experts are debating exactly the same issues. Being able to track the process towards a good outcome and benchmark funds’ performance against their peer group is crucial and a current key focus of the Australian government.
To make comparisons between the various superannuation funds easier, the government is working on legislation to introduce investment dashboards, explains Jeremy Cooper, the lawyer who chaired the seminal Cooper Review into superannuation, the compulsory Australian pension system. Each superannuation fund will be required to produce a dashboard, setting out the main characteristics (including past performance, volatility and fees) of the 10 largest investment options the fund offers to savers.
In Australia, members of a particular workplace superannuation fund can move their money to a different scheme, run by a different provider, if they feel their own superannuation fund is not up to scratch. By contrast, UK members of workplace pension schemes are bound to the provider their employer chooses.
Australia’s dashboard bill is currently out for consultation. The Australian Treasury hopes it will pass into legislation in July 2016. If it does, it will be interesting to see how many savers engage with the dashboards. Cooper is mindful of the challenges, saying: “Does the average Australian sit down with the interest, patience and technical knowledge to go through all of this? There has been some consumer testing but we’ll have to wait and see.” Even so, he is cautiously optimistic technological advances may make this sort of information more accessible to savers:
There is an old saying – if you want to manage something, you have to measure it. When the industry is held to higher levels of transparency, it induces another type of behaviour than when things are less transparent.
Other performance measures
Investment dashboards are one way to benchmark performance but another way some Australian superannuation funds have sought to measure performance is via the net benefit model. A group of superannuation funds called the Industry Superfunds offers savers a fund comparator, allowing them to make comparisons between the group’s performance and the net performance of the 85 retail superannuation funds it tracks. It also shows savers the net benefit difference between the collective performance of the superfunds and the retail funds.
Brett Jollie, Aberdeen Asset Management’s managing director for Australia, stresses the net benefit model is only one of many comparison tools that are emerging. “We are going through the same discussions here around what is a good outcome,” he says. “Every pension fund or superfund looks for its own definition of success when it looks to assess how it is going. The net benefit model is just one type of model that is being used over here.”
Back in the UK, Steve Budge, a principal in Mercer UK’s DC and savings team, is wary of comparing investment performance. “The difficulty around comparing investment performance is that past performance should not be used as a measure of future performance,” he says. Budge also points out that the rules about switching provider are different in the UK to Australia.
It could be destabilising to give that information to members and say ‘You’re in a really bad default’ and then they can’t change. Budge also thinks – and this is a view reaffirmed by Cooper – that Australian default funds are relatively similar to each other, making them easier to compare than UK defaults, which are a broader church.
The Financial Conduct Authority has in fact mooted the idea of a pension dashboard. In the UK, however, the idea is that such dashboards would act as less of an investment comparison tool and more as a way to help savers see all their retirement savings in one place. The dashboards do have something in common though – they are designed with the idea of giving savers more information, in a clear and accessible way, to empower them to make better choices.
Mind the savings gap
Of course, the challenge in the UK go beyond transparency. For one thing, it is fairly well-accepted in the UK that most savers are not putting aside enough to be assured of a comfortable retirement. The Pensions Policy Institute estimates that, to have a reasonable chance of a comfortable retirement, median earners need to put aside a combined employer/employee contribution of between 11% and 14%. At the moment though, employees who meet the auto-enrolment threshold are, on average, saving 6%.
Mercer’s 2015 Global Pension Index, which ranks 26 countries on their pension systems, gives the UK a grade B, leaving it trailing behind Australia, Denmark and the Netherlands – especially on adequacy, which is one of the three sub-values that makes up each country’s individual score. The UK scores 64.2 on adequacy, which is higher than the average 63.8 but much lower than Australia’s 81.2. To propel the UK to an A-grade, the report recommends increasing the level of contributions to occupational pension schemes.
On the bright side, Mercer’s Budge, believes some UK schemes are doing a good job of communicating with savers about how they are doing on the journey to retirement, which will hopefully encourage them to act if they are not saving enough. Using various salary replacement projections, schemes are saying to members that if they put in a certain amount of money it will lead them to a good outcome in retirement, he says.
The difficulty is that schemes do not have a holistic picture of people’s savings, he continues, adding: “We put it in the context of the scheme: ‘You are saving well as we would expect for your age and salary. But you have only worked here for three years so we are expecting you to have wider savings elsewhere.’ That is the difficulty for schemes – particularly in this country where DC is still quite new for the masses.”
The retirement dilemma
Back in Australia, attention is turning to the retirement phase. “Our big dilemma right now is that we are good on the accumulation phase but not the decumulation phase,” says Russell Mason, a partner at Deloitte in Sydney. “We say on retirement, ‘Here’s one million [Australian] dollars – good luck!’”
Indeed, somewhat ironically, Australian experts are looking to the UK and its annuity market for answers. “I think in the accumulation phase we are well ahead of the game,” says Mason. “But I think we would turn to you for advice on the decumulation phase. Our annuity market still needs to develop further.”
At present, the Australian tax system disincentivises retirees from buying annuity products. The government is currently reviewing this situation, explains Mason. He and his colleagues were surprised when the UK pension freedoms came in. “Part of us said ‘Why? Guys you are going in the wrong direction. We are doing everything we can to encourage people to keep their money in the system and you seem to be doing what you can to encourage people to take it out!”
The uncertainty in Australia around what happens at the end of the savings process pinpoints why it is so important to set clear objectives in the first place. When it comes to good outcomes, setting clear objectives is Jollie’s advice to UK decision-makers. He believes enshrining clear principles in legislation is a vital step in his own country, adding: “It sets the goalposts for policymakers, for legislators, for regulators and the community.”
Setting an objective for superannuation might sound quite an obvious exercise – a definition could be along the lines of: “to provide a comfortable retirement for all Australians while reducing the pressure on the old age pension”, suggests Jollie. However, he believes it is important nonetheless. As the superannuation pool of funds has grown, there have been many different calls to raid this increasingly tantalising pot of gold, he explains.
As an example, there have been calls to increase tax on superannuation funds to bolster the government’s coffers. Others have called for superannuation cash to be invested in infrastructure projects that will benefit the country. While improving the country’s infrastructure is clearly an important priority, it is important for savers’ investments to remain well-diversified and some types of infrastructure investing can be high-risk.
“Defining the objectives of superannuation will serve as a guide to policymakers, regulators, industry and the community about superannuation’s fundamental purpose,” concludes Jollie.
Laying down the law
Understandably, the UK government has focused on encouraging people to save. However, the Australian example illustrates the importance of enshrining broad principles in law. Otherwise, we could find ourselves having the same argument about how UK savers’ assets are used, further down the line.
The good news is that we have some time. Those retiring in the next decade are likely to have significant defined benefit pension income; while the IFS is clear that the generation born in the 1940s is overwhelmingly in retirement surplus not deficit. Learning lessons from Australia, on what does and does not work, is as good a place to start as any.
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