The Pensions Pod S6:E3 – DC Decumulation: The nastiest, hardest problem in finance?

Kathryn Fleming (00:34)

Hi, lovely to be here.

Chris Brown (00:36)

Thank you very much, you’re very welcome on the Pod. So, Kathryn is the Head of DC Consulting at Hymans Robertson and partners with clients to solve DC strategy, benefit and reward problems. So, Kathryn, just briefly, can you let us know who you are and what you do and a bit about the work you do, please?

Kathryn Fleming (00:52)

Yeah, no problem. So yeah, my name’s Kathryn. I’ve spent the past three or four years looking at decumulation and trying to look at it from lots of different perspectives. So, what it is for the members, what it is for trustees, employers, and really trying to push forward the conversation and trying to help the industry grapple with some of the challenges that decumulation is going to introduce. So yeah, really, really excited to be here today to talk about that.

Chris Brown (01:22)

Yeah, thank you. And it really is going to impact all stakeholders in the industry, isn’t it? Everyone’s going to have a slightly different view, member, trustee, employer, provider, and we’ll come on to some of those later on in the Pod.

Kathryn Fleming (01:34)

It’s exactly that. Yep, everyone’s starting from a different position. So yeah.

Chris Brown (01:38)

Brilliant. And we’re also joined by our very own Helen Woodford, who’s a Director in our team. Hi, Helen, do you want to say hello and who you are and what you do?

Helen Woodford (01:46)

Hi, thanks Chris. Yeah, I’m Helen, as Chris has just introduced me. I’m a Director in the Burges Salmon Pensions team. I’m based in our Edinburgh office and like Chris, advise trustees and employers on DB pension issues, but more importantly for today, DC pension issues too.

Chris Brown (02:05)

Yeah, exactly. Well, hi to you both. And thanks very much for coming on the Pod.

So, Helen, if we could start with you, please, could you give us a brief introduction to, well, what is DC decumulation? What’s the current law and what are these changes coming in the Pension Schemes Bill?

Helen Woodford (02:26)

Yeah, of course. So, to be as brief as possible, basically, decumulation is the opposite of accumulation. So, in the accumulation phase, members are building up their DC pot. And after the introduction of auto enrolment, actually, they’re building up those pots without much, if any, real engagement on their behalf. You know, their contributions are just going out from their salary and being matched or provided by employers. So, then we get to the decumulation phase when members come to retirement age. I think an issue we’ll no doubt touch upon today with Kathryn’s views are there’s no one size to fit all here. And even the needs of an individual member may change over what could be a very long retirement period.

Chris Brown (03:22)

Yeah, absolutely. As their sort of health and, you know, family circumstances change.

Helen Woodford (03:27)

Yeah, sure. So, with the current law, since the introduction of pension freedoms in 2015, members of DC schemes can have flexibility in how they access their pension pots at retirement. So common options include purchasing an annuity to provide a guaranteed income for life, taking a pension commencement lump sum up to 25 % tax free to be taken at the point their benefits crystallise. So, before the pension freedoms were introduced, they were the two options basically. So, with the pension freedoms along came flexi access, draw down, members can take an adjustable income over their retirement period and also in crystallised funds, pension lump sums. So instead of taking one lump sum at the point of retirement, members can take lump sums over the course of their retirement in chunks with 25% of each pot being tax free.

Chris Brown (04:30)

So, they were freedoms that came in in 2015, which is kind of where we are now. So, what’s changing with the Pension Schemes Bill?

Helen Woodford (04:39)

Yeah, so the Pension Scheme Bill is currently making its way through Parliament and we expect the decumulation aspects of that to be in place, we’ve been told 2027 at the moment. So, trustees will now be required to design, make available and review at least one default decumulation solution. So those options were available from the point Pension Freedoms were introduced but you know, I don’t think we’re seeing too many trustee boards incorporating them into their own schemes right now. Yeah, or to offer. Yeah, at least one default decumulation solution, whether that’s within their scheme or elsewhere. There’ll be requirements too for trustees to provide members with information about the solution and what types of member it might be suitable for.

And also powers to request information for members to determine the appropriateness. And trustees can transfer members to other providers with the member’s consent if they can’t offer the solutions from their own scheme. And there’ll be Pension Regulator enforcement powers to make sure trustees do take these new duties seriously.

Kathryn Fleming (05:52)

So, Accumulation to me is basically where, you know, the past 10, 15 years, the DC industry has been focused. So, to me that’s saving. So, how much, how much money is going in, what’s the contribution design, how can you invest that money and get a return? So, most of the conversation has been around inputs as opposed to outputs. And the language has evolved to outcomes, which is fantastic because that’s really ultimately we want people to have good member outcomes. So decumulation is then the spend phase.

And I think it’s actually really interesting to think about the member’s perspective around all of this as well because I think one of the things that the Pension Bill is trying to solve is a member has a completely different retirement experience depending on what pension vehicle they actually accumulate their money in. So, if you think about a group personal pension plan, someone’s accumulating money, they get to retirement and it’s kind of, you’ve got to go and make those choices that you outlined.

You might have something at the opposite end of that where you have a master trust where you can actually start to get a complete to and through experience. So, a member can go from accumulation into decumulation. So, there’s a bit where the Pensions Bill is trying to get the own trust market to try and level it up a wee bit to try and get that same level of experience and just help members get to and through retirement a bit better. And the reason they’re doing that is I sometimes discuss describe if you’re taking your money out and you’ve got to go and figure out what you want to do with it. It’s a bit like entering the Wild West. There’s so many different solutions. There’s so many different ways you could draw your money down. ⁓ So yeah, it’s quite important to try and put more guardrails and safety nets around that for the members. And this is a really tangible step that the pension bill is trying to achieve there. And Chris, yeah, you were spot on there with kind of health and family circumstances.

I think what’s really interesting is some of the supporting language that has been used around this. So when the Pensions Bill was announced in June, they were talking about requiring trustees to take into account their members’ characteristics and preferences when they are looking at these decumulation solutions. And that’s really, really hard to do. If you’re thinking about as a trustee, you see an element of data around an element of time that someone has been in your pension scheme, but you don’t see all of the other wealth and family circumstances around that. So whether someone’s getting ready for retirement and they’re married, so they’ve perhaps another second source of income, or you don’t see all of their DC pots. And you might not in some cases see where they’ve actually got a DB benefit as well. Trying to think about something that takes into consideration all these different characteristics, it’s going to be very tricky to do.

Chris Brown (08:53)

So, I’ve seen it said, well, I think I know what you would say to this, Kathryn, but it’s more than just rebadging of the 2015 freedoms, isn’t it? It is a whole new policy shift with new duties and will be something very different for the industry to get to grips with.

Kathryn Fleming (09:12)

Yep. Yeah. I agree with that. Yeah.

Chris Brown (09:14)

Yeah, so I’ve also seen it said that it’s the nastiest, hardest problem in finance. So turning defined contribution savings into sustainable retirement income is the nastiest, hardest problem in finance. Can you tell us a bit about that quote? Do you agree? And, you know, sort of what are the factors that lead into that view?

Kathryn Fleming (09:38)

Yes, I am. I’m going to say yes, I definitely agree. And because, right. So, again, back to if you think about accumulation versus decumulation, accumulation had a single objective. Decumulation for me doesn’t, although I do recognise income is the preference. But, people reach retirement and they have their own vision for how they want that to look and feel like. So, it could be that they want to use any DC savings to provide an income. They might want to use the DC savings to leave that as a pot left behind to pass on to wealth to your family. They may have a vision in their head that they may be got a DB benefit somewhere else so they want to use the DC pot almost like their drawdown savings vehicle so I should be careful with the word drawdown there a savings vehicle that they might want to use for one-off costs and actually there’s some statistics there where people are using their DC pots to pay off debts so when they were talking about the pension commission they were making references to information and different surveys, the planning and preparing for later life survey. So, 30% of people who took their lump sum used it to pay off debts. So, there’s a whole host of different wants and needs of members for how they want to use their DC savings in retirement. So, it’s not a single objective. So, to me, that is the trickiest bit. And each of the different pension providers are trying to look at their own databases, understand those characteristics and preferences and therefore come up with what they think is the most appropriate decumulation solution. And it’s important to understand the providers and their approach because what I’ve seen is most of my trustee clients are going to, instead of trying to solve that nasty problem themselves, they’re going to rely on a third party to do that. And that’s most likely to be one of the pension providers, primarily likely to be partnering with a master trust.

So, understanding how they’re approaching solving that nasty problem is going to be really important as well to make sure it’s the right type of approach that fits with their own membership. So, trustees thinking about that kind of match, will it reflect the wants and needs of their own members as well? But on top of that, so back to what you said Chris, around kind of health, wealth and family factors, the reason it’s quite tricky as well is we’ve got a number of statistics about how people just actually fundamentally underestimate how long they’re going to have to have their money to last for in retirement. So, they really underestimate their life expectancies. So, typically men underestimate it by about five years, women underestimate it by about eight years. So, that’s a huge gap if you’re doing your financial sums and you’re not factoring in that, you know, the money could disappear if you’re not letting it stretch long enough. So, there’s a real bit around how can we help people really see themselves and the different uses for their money.

And yeah, it’s a nasty one, but hopefully we can come up with something.

Chris Brown (12:40)

So, Helen, there’ll be lots for sort of communication with members then will be absolutely key.

Helen Woodford (12:46)

Yeah, you know, from a legal perspective, we get involved in reviewing communications, our trustee clients send to their members on a whole host of things. But obviously, this will be something, you know, we’ll get to look at and would want to help with. It’s a difficult balance, isn’t it, between getting all the points and you need to sort of cover trustees’ duties and make sure our trustee clients are protected from risk and what they’re saying there. But, putting things in the language the members understand and you know maybe different cohorts of members as well. As mentioned before there’s not a one-size-fits-all here is there? How to get members to engage you know it’s important what goes in those communications. How do we get members to engage?

Kathryn Fleming (13:34)

Do you know what it is? It’s a really good one and I think, so Helen you and I were having a chat about this previously, I think there’s really interesting interactions between the pension schemes bill and what the FC are trying to do with targeted support. And there’s arguably maybe some kind of conflicting language in there just now, so definitely a real legal view around interpreting that and understanding how all of that fits together and how they will influence each other.

But as well, so I mentioned some of our clients are partnering with a master trust. So, you’ll have seen questions come up with trustees around, where does my duty start and stop around that? So, I do think there’s a consultant like me can really help understand what the pension providers are offering. But there’s definitely a role for legal advice around whether this is actually the right solution and how you understand your duties and who takes the decisions around that.

Yeah, there’s a lot to consider.

Helen Woodford (14:35)

And obviously there’s a whole host of pension developments in the pipeline, including pension dashboards. So maybe with dashboards coming in, members just will improve their understanding of their pension benefits and just have greater engagement with all the communications that are coming across to them.

Kathryn Fleming (14:54)

Agreed. And employers have a role in this as well. So, it’s understanding to what extent the duty is placed on trustees, but sometimes it’s the employer who has to pick the pensions vehicle and has to make the decision around whether you want to kind of have that third party involvement. And actually, from my experience, a lot of the employers like to support because ultimately at end of the day, they want an engaged workforce, and they’ll have their own idea of what workforce resourcing strategies look like. So, it’s important for the trustee and the employer to be having a conversation around what an appropriate way of supporting and managing money and finances and how you help people make better choices because it all fits together. It feeds into financial wellbeing strategies as well.

Chris Brown (15:42)

That is absolutely and you know that that must be right and in trust-based schemes, I mean employers will necessarily have to engage, not least because if any amendments to schemes are needed to allow trustees to do what’s required under the PSB, then employers might have a role in exercising that amendment power. But also, if you know there is better engagement and more information, people understanding better about, decumulation solutions, then that is going to impact what people do when they come to retirement age. And that will impact the employer’s business if people stay in employment later and use Flexi Access or Drawdown or UFPLS or whatever else. So, there is definitely role for employers to understand these changes and how they might impact businesses?

Kathryn Fleming (16:35)

Exactly, yeah and I’ve seen a number of employers who are thinking about what types of role they would naturally lend themselves to part-time working over a longer term to help people extend their working life. So yeah, definitely. There’s a lot of stakeholders involved here and I think as well, so what I’m seeing with the pension providers and what they’re thinking about in terms of decumulation solutions, they’re very, very different.

So, an employer might have a view from a reputational perspective to what extent they want to be associated with these very different decumulation solutions. So, we’re seeing everything from pension providers wanting to be an investment led solution, so a drawdown solution, with a degree of kind of guardrails and communication supporting that, to the opposite end of the spectrum where we’re seeing some of the pension providers are thinking about how to put in a CDC decumulation solution. So that’s collective defined contribution.

And to me, it has an element where it’s maybe a wee bit higher risk in the sense that it’ll be harder for someone to exit if they kind of get defaulted into it and they think, gosh, what’s happened to me? Do I want to be here? So, it’s a very different type of solution, but the CDC one’s a really interesting concept because it could potentially make money go a lot further. So, you’ve got those trade-offs that you need to consider around whether you want to help people get as much as possible, or you want to kind of balance and preserve that flexibility and those freedom points. So yeah, the range of solutions is going to be a really interesting one.

Chris Brown (18:08)

And speaking of trustees and how they’re responding, so Helen, I just wanted to ask you the sort of refocus on decumulation rather than accumulation. Is that a significant shift in trustees’ core duties?

Helen Woodford (18:23)

Yeah, absolutely. they’ve got, you know, we’ve talked about the regulatory duties and how they may change, but there’s the underlying trust law duties, the fiduciary duties to act in the member’s best interests. And we know leading case laws interpreted those to mean, you know, that members best financial interests largely. So, yeah, clearly, I think, you know, whether the legislation’s changing or not, trustees have a duty to consider the best options for their members and how they can best provide those either through their own scheme or through another vehicle if that’s not possible through their own scheme. So yeah, it’s a focus to remember there I think, regardless of how the law changes and what the pensions regulator might say about it.

Chris Brown (19:07)

Yeah, absolutely. And they’ll want to have a good decision-making process, protect themselves from the risk of, or potential risk of future member challenge. So, with that comes all the things that, you know trustees will ordinarily do to protect themselves. So, take proper advice, ensure they know what their protections are in place, indemnity provisions or insurance, and then ensure they have that, as you were saying earlier, good quality member engagement, quality DD on third party providers if they do look for third party providers to provide things. So, to make sure they’re meeting their fiduciary duties in offering the new things.

Helen Woodford (19:47)

Yeah, and we’ve talked, there’s a lot of options out there and, you know trustees don’t have to offer them all, but they should probably consider them all to work out what’s best fit for, you know, their membership and the different cohorts of

Chris Brown (20:00)

Yes, and I think the regulator, so Patrick Coyne, who’s the interim Director of Pensions Reform has recently published a blog and said that he wants to see trustees see this as an opportunity to lead. So, trustees will really have a leading role in the reform here. Which leads me, I suppose, on to perhaps I could come to you both to ask you for a final thought for our listeners. So, the Regulator has recently referenced DWP research from 2024, planning and preparing for later life, and it was updated in summer this year. And there are some stark statistics in there. So only 22% of savers who haven’t yet accessed their DC pot have a clear plan of what to do with it. And 21% of savers didn’t know that they had to make a choice at retirement. So there’s clearly an issue here that needs solving in the industry. The Regulator as I say, wants trustees to see this as an opportunity to lead. And so, Kathryn, what would be a final thought you can leave our listeners with, please?

Kathryn Fleming (21:15)

Yeah, so my sense is there’s a lot that you could do as a group of trustees because you have access to data and you understand your direct pool of members. I think it’s not probably an option to do nothing anymore, so there’s definitely an action where you can take a step forward. But if you are doing this with your own membership in mind, you are able to ask better and good questions of your pension providers.

So, you’re able to at least know where your gaps are in terms of your communications and how you access different options for members. And a first step forward would be to figure out how to fill some of those gaps with the kind of the gold standard aim of working towards 2027, 2028, where you know what it is that you want, what would be the right type of decumulation solution for your members. So, figure out how to take steps towards that. Doing nothing is not okay anymore.

Chris Brown (22:12)

Yeah, and the regulator has asked trustees to do that, to do exactly that, consider their decumulation strategies now to deliver better retirement outcomes. And super, Helen, same question to you if that’s OK, please?

Helen Woodford (22:26)

Yeah, I think I’ve already mentioned this, think, in our conversation, but it’s just, yeah, struck me as we need to really focus on what we’re putting out there in communications to members. I think we’ve, you know, looked at different versions of member announcements over the years for different reasons, you know separated into active members, deferred pensioners, but perhaps now we need to add a few more categories to that within the pensioner you know, coming up to pensioner age cohort, because it’s not just a decision to be made. That’s the decision they’re stuck with you know, that there can be numerous options, you know, flex and fix later I think Kathryn’s a term, isn’t it?

Kathryn Fleming (23:11)

Definitely is. There’s a thing for me where this all boils down to some good sample members. If you have that, you’ve got your natural cohorts and you can start thinking through the different lenses of those members. So, yeah, I agree with you entirely. Let’s get a good understanding of your cohorts.

Chris Brown (23:27)

Super. Well, it feels like we’ve only scratched the surface really of this discussion, but that was a really interesting introduction. So, thanks very much for coming on the podcast.

So, it was great to chat again about pensions on the Burges Salmon Pensions Pod. If you’d like to know more about our Pensions and Lifetime Savings team and how our experts can work with you, then you can contact myself, Chris Brown, or Helen, or any of our team via our website. And as we say every week, all of our previous episodes are available on Apple, Spotify, our website, or wherever you listen to your podcasts. Don’t forget to subscribe, and thanks for listening.