More people are opting for the drawdown of their pension over buying an annuity. However, the downside of that is retirees from defined contribution (DC) pension schemes are now taking on whole new areas of risk to which they haven’t previously been exposed - including inflation/investment risk and mortality risk.
Members can, of course, take advice and do their own research to manage their drawdown investments, reducing the possibility of inflation eating away at the value of a pension pot, even after investment returns. The problem is that mortality risk cannot be dealt with in the same way. Once you’ve retired, how can you effectively manage the risk of your DC pot running out before you (expect to) die, without locking into an annuity? Mortality risk therefore represents the biggest threat to wiping out a DC pension outright.
The days of gold plated private-sector defined benefit (DB) schemes are numbered. Membership of DC schemes are now a staggering 26% higher than membership of DB schemes. From now on, retirees will be faced with choices and risks they have not previously had to manage, if they choose not to take an annuity.
When a DC scheme member reaches retirement, their pot of money will, in the absence of other benefits, need to last for potentially over 20 years – a significant period of time. Many of us are comfortable with some degree of risk in terms of our investments – but that risk becomes far more critical, if your living standards as a pensioner are effectively on the line.
The table below shows, in broad terms, who shoulders responsibility for two of the key at-retirement risks in pension schemes.
|Inflation / Investment risk||Mortality risk|
* assuming an annuity isn’t bought with the DC pot at-retirement.
The difference is stark: in a DC scheme, the risks at (and sometimes in) retirement rest solely with the member, particularly for those people who choose to use drawdown at-retirement, instead of purchasing an annuity. Of the two risks above, mortality is far more difficult to assess. It’s the elephant in the room: everyone knows it’s there but, but many still tend to ignore it.
There are several issues to consider:
Pension scheme members generally underestimate their life expectancy. How can sponsoring employers and trustees therefore help to ensure that future generations don’t run out of resources?
For further information, please contact Emma Skedgel.