The most radical pensions overhaul in nearly a century has arrived. These changes offer employees in a defined contribution (DC) scheme who are aged 55 or over greater flexibility in how to access their pension. But without the right financial education, employees could be left incredibly vulnerable to making poor and costly decisions.
Many employees start working life with only the most basic financial knowledge, so an effective financial education strategy should take account of this and support them throughout their career. In the years leading up to retirement and at the point of retirement, it is even more important due to the choices an employee can now make about their retirement income options.
Good starting point
A good starting point is to consider what the appropriate age is to begin this process. In Wealth at Work’s experience, 45 has become the new latest age to begin planning for retirement. It is a move from the traditional idea of educating those just a couple of years away from retirement but is more effective because, given the new rules, choices need to be made much sooner.
Gliding towards retirement
For example, an area that is a cause for concern is that employees need to give greater consideration to their retirement glide path. Glide path refers to a chosen investment route that will take an employee up to the point of retirement and potentially beyond. It is a formula that defines the asset allocation mix of a pension savings fund based on the number of years to the target date, usually the anticipated date of retirement. The glide path typically creates an asset allocation that becomes more conservative or takes less investment risk (that is, it includes more fixed-income assets such as bonds and fewer equities) the closer a fund gets to the targeted retirement date.
However, experience indicates that employees find selecting funds for their pension confusing at the best of times, and most choose to invest in the default fund provided by their workplace pension. Prior to the pension changes, a lifestyle approach was used and the asset mix in the default fund changed as their retirement date approached, for example including more fixed-income assets in their late career. This is because the default option assumed that an employee would buy an annuity in the future.
Many organisations are realising this will not now be the choice made by many and consequently want employees to look at their glide path at least 10 years before their anticipated retirement date, because if they want to choose another form of retirement income such as drawdown, they may wish to address their fund selections at this point. In other words, pick a more suitable glide path.
This is very important because the new pension changes have made more retirement income options accessible to all pension savers, for example taking a whole pension fund as cash or buying an annuity, going into drawdown or a combination of some or all of these. If employees have selected a default fund that is geared towards an annuity purchase at retirement and they are now considering drawdown, they should consider other fund choices, for example exposing them more to equities and less to fixed-income assets.
Of course, if this is the case, employees will need financial education in order to understand this and have the confidence to make their selections.
And it is not just about pensions. Employees now have to think beyond pensions and consider all savings, such as individual savings accounts (Isas), share schemes and any deposit accounts, because the tax-efficient withdrawal of cash from pensions or any other savings to use in retirement should be an important consideration.
Post financial education
Of course, once employees have received financial education and are at the point of retirement, they will want to know what they need to do next and how to do it. This is where regulated advice can help employees make the right choices at retirement and prevent costly mistakes from being made.
Jonathan Watts-Lay is a director at Wealth at Work.
