DC investment. The more things change...
One of the topics explored in our recent survey of FTSE 100 DC pension plans was investments. You can find out more about the survey here.
We were particularly interested in the changes prompted by Freedom and Choice. We found evidence of a lot of change, and some areas that were curiously unchanged.
Prior to Freedom and Choice’s introduction in April 2015, nearly all default lifestyle strategies targeted an investment mix of 25% cash and 75% annuity-matching assets at retirement. And with good reason: 95% of members chose to buy an annuity (despite the availability of drawdown since 1997), and legislation meant members had to take their lump sums and buy an annuity within a few months.
What’s changed in default investments?
The main change we found was in the style of retirement income being targeted at retirement. Our survey showed that only just over half the companies surveyed are now targeting annuity purchase alone at retirement.
The fact that almost half have moved away from targeting annuities tells us something else - that at least half of the plans surveyed have reviewed investments in the past couple of years (and by extension, that investment consultants have been busy with their recommendations). No doubt many of those still targeting annuities also carried out a review. That’s a great endorsement for the active governance of DC plans.
Thus far, we have a year of post Freedom and Choice data from the Association of British Insurers. A little over 20,000 drawdown policies are being established each quarter. That compares to fewer than 20,000 drawdown policies a year being set up before the legislation changed. However, annuity sales are also running at around 20,000 a quarter, although there is some talk that more of them are of the 'enhanced' variety than used to be the case. So while drawdown policies are definitely far more popular than they used to be, talk of the death of annuities is premature.
When the new legislation was announced, there was much speculation that income drawdown would become the income solution of choice for those with larger funds. The average drawdown fund in those first year has been £67,500, whereas the average annuity purchase over that time has been £52,500. Although those selecting drawdown do have larger funds, they are not that much more substantial.
Notable too are the handful of plans that are now targeting cash withdrawal at retirement. Around 300,000 people cashed out of pensions in the first year since the new legislation, c.167,000 of them in the first six months. To date therefore, cashing out has been the dominant choice of retirees. Will this last? The average cash sum paid has been around £14,500, which strongly suggests that cashing out is more popular to those with smaller funds.
It appears that it might be easier to predict what people with relatively small funds will do (cash out) than it is to predict what people with larger funds might do, and that dilemma is captured within our survey category of ‘combination’. Four in ten plans are targeting a mixture of outcomes, usually annuity and drawdown.
What hasn’t changed? Quite a lot. I’ll cover that in a separate article.