By Paul Sweeting
The Australian market has made great strides in superannuation. Compulsory contributions – which would be very difficult to introduce in a post-financial crisis world – have resulted in significant balances being accumulated by many people.
But getting money in is only one part of a successful pension system. It is also important that these assets are withdrawn sensibly. In particular, these are supposed to be contributions for superannuation, not lump sum saving. The Australian tax system makes this difficult to achieve – when people reach retirement, they can generally withdraw their entire fund free of tax; at least in the UK and the US, there is an incentive to withdraw assets slowly, as payments out of the funds are taxed.
However, one way to overcome the incentive to take a lump sum is to rely on inertia. Default funds could be created that not only accumulated assets, but paid these assets back out in a controlled fashion. The drive to decumulate could be further helped if fund reporting concentrated more on income than on fund values – a move that is already being seen in Australia and elsewhere. This could encourage people to see the contributions that they were making as payments that would ultimately produce a stream of income. And by having a default that stayed as a fund in retirement rather than turning into an annuity, people would not have to hand over all of their assets to an insurance company, with nothing to pass on if they didn’t survive as long as they hoped.
Having a single fund both before and after retirement also means that a sensible investment strategy can be constructed for both phases of life. Just as importantly, this strategy can be based around the income that will be received, avoiding metrics that focus on fund values.
So together, defaults and decumulation could help to ensure that superannuation funds are used for all of retirement, and not just as tax-advantaged savings vehicles. In addition, they can take care of the investment strategy in way that recognises the link between the build up of assets and their subsequent withdrawal.
But could such an approach work in the UK? With the impending end of near-compulsory annuitisation, the post-retirement landscape has suddenly opened up. The guidance guarantee might suggest that it is less important to have a default after retirement, as people should be guided to the most appropriate solutions for their particular circumstances.
However, the solutions that people will choose will always be judged relative to their current direction of travel, and if the default is a glide towards cash then the focus will always be on the lump sum. However, if people are in an accumulation default that will – if nothing is done – turn into a decumulating product, then any alternative should be measured in terms of the income that it can provide.
This is partly a question of relying on inertia, but also of anchoring peoples’ decisions to income rather than capital values. As such, pre- and post-retirement funds that decumulate automatically could find a home in the UK – and could ensure that pension schemes continue to be used to provide retirement income.
Paul Sweeting is European head of Strategy Group, J.P. Morgan Asset Management
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