Defined contribution (DC) pensions provide new opportunities to address retirement income challenges, but the UK can take lessons from countries with more developed DC pension systems to improve member outcomes, according to a Pensions Policy Institute (PPI) report.

The PPI’s latest research report noted that while the UK had the second largest stock of pension assets in 2021, it was some way behind Australia, the US and Canada on the path to a fully formed DC system.

It also warned that the UK may need to address the issue of people not drawing down significant DC pension assets in retirement at a rate that would meet adequacy levels.

However, the report found international evidence that encouraging individuals to withdraw sufficient income from their retirement savings was problematic and could require advice, delivered in a consistent manner in a simple system, to help people’s decision making.

The absence of prescribed minimum or maximum rates of decumulation or default decumulation solutions in the UK meant that initiatives such as Australia’s ‘Retirement Income Covenant’ and New Zealand’s ‘Rules of Thumb’ framework were “particularly relevant”.

“Successful interventions of this type may be necessary if we are to attain acceptable replacement rates for those requiring significant reliance DC pension assets to generate adequate retirement income,” the PPI noted.

“Complexities arising from means testing and tax incentives or penalties can make decisions for individuals more complex and choices more challenging. In these circumstances, policies designed to constrain choice, such as the required minimum drawdown provisions in the US, Canada and Australia, may unintentionally become de-facto defaults.”

It noted that workplace DC pensions must be considered as part of the wider pensions system, highlighting that both Australian and Dutch policy and regulation have recognised the need to segment retirees with regard to their financial situation and preferences.

However, the PPI warned that outcomes in other countries may not transfer to the UK system in the same way, as each has a unique pension system, and using a framework to compare other systems with the UK would aid the assessment of how lessons from other countries would best apply.

While there were lessons to be learned, the PPI highlighted that flexibility of DC within the UK would provide opportunities to address changing retirement patterns and risks.

It noted there were a variety of approached to mitigate inflation and longevity risk, and the approach taken in other countries was typically a factor of the wider pension system and society’s appetite to pool or bear risk individually.

“Group structures, such as employers and industry schemes, have a potentially important role to play in improving value and choice for retirees,” the report stated.

Furthermore, the regulator has an important role to play in enabling consensus on guidance, as well as appropriate and timely consumer protections, with the PPI stating that the UK has opportunities to learn from regulators in Australia and New Zealand on initiating or adopting strategies and gaining consensus around how to improve consumer support and guidance at retirement, and from Denmark and the Netherlands in regulating the journey to variable income lifetime annuities.

“While the UK pension flexibilities resulted in stakeholder concerns that pensioners may overspend their DC savings, retirees in the USA, Australia and New Zealand are often reluctant to spend down savings, to the point that in the USA, the majority of retired people retain at least 80 per cent of their savings around 20 years into retirement,” commented PPI head of policy research, Daniela Silcock.

“Underspending is as worrying as overspending, as both mean that pensioners may be living on a lower than adequate income.

“Both Australia and New Zealand are in the process of implementing systems to assist retirees to draw an income more effectively, and their success with these will be of great interest to the UK. Especially the New Zealand Retirement Commission’s ‘Rules of Thumb’ guidance, which will allow people to choose profiles and withdrawal rates based on their retirement needs and preferences.

“The success of these initiatives will help answer the question of whether guidance can be a substitute for defaults, when it comes to enabling decision making. However, if neither New Zealand, nor Australia, find they can support retirees simply through guidance, the UK may need to think again about the role of defaults in pensions access both to avoid under and overspending.”

Also commenting on the report, Columbia Threadneedle head of pensions and investment education, Chris Wagstaff, said: “Three things are clear, the first is that a collectivist solution, one which pools the largely unquantifiable risks that accompany flexibility in decumulation, trumps an individual retail-type solution.

"Consequently, decumulation-only collective DC, while not yet a reality in the UK, already has a core band of supporters.

“The second is that the success of automatic enrolment in the accumulation stage of DC is testament to the power of harnessing the inertia of the disengaged by opting eligible employees into pension saving and so should be replicated in decumulation.

“The third is the legendary power of the default. In pensions, as in all aspects of life, the default option is that which is overwhelmingly selected.”

Standard Life managing director for individual retirement, Claire Altman, added: “The report highlights that despite the UK being home to the second largest pool of pension assets, we are far from being the most advanced in our thinking about accessing DC savings.

“When pension freedoms were introduced in the UK, the assumption was that biggest risk to people’s retirement was drawing too much income too quickly, but the report highlights that the opposite is often the case. In other jurisdictions, there is just as much emphasis on taking a minimum income as on taking a maximum income and policymakers often have a clearer idea about the requirements of different customer segments.

“While there are significant differences between pension systems globally, there are common challenges around optimising income and managing longevity risk. It is helpful to understand the approaches taken by other pension systems given the historical lack of innovation in the UK retirement income market.

“Looking ahead, this is something the wider industry must tackle. While rising interest rates have led to renewed interest in the value offered by a guaranteed income, solutions need to go further.

"Attention must now turn to providing options that combine people’s desire to optimise their income, with the flexibility to manage their pension savings, alongside the security and certainty of having essential expenditure secured through a guaranteed income.”

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