What if the hardest problem in finance is actually even harder than we thought? And what if less freedom is better than more?
The words “pension decumulation” are enough to glaze most eyes. Add “cognitive decline” to the picture and the result is actively offputting. Yet this is important — financially, socially and philosophically.
Decumulation is what awaits those of us who have only defined contribution (DC) pensions, pots of capital we accumulate over our working lives to support us in retirement.
Working out what to do with the money — where to invest, how much to spend — requires individuals to make some near-impossible guesses. How much will the money grow by? How will my costs change? How long will I live?
This is the “pension freedom” that George Osborne casually imposed on future generations in 2015. The more time passes since that easy phrase was coined, the more difficult the reality has come to appear.
Most people accessing DC pension pots don’t get proper advice — understandable, since regulation has made that advice prohibitively expensive and left financial services firms afraid to offer even the vaguest counsel.
At present, the stakes here are relatively low because many retired households have some defined benefit (DB) pension entitlement too, and because DC pots are often still small. But as DB recedes and DC grows, decumulation will involve big money and big consequences. By 2035 most retired people will be relying primarily on DC assets for their pension income.
Expecting people to act like textbook rational economic agents is always bad policy. When those people are gradually becoming less able to process and calculate and manage, it’s downright irresponsible.
And growing evidence shows something we all instinctively know to be true: our faculties decline over time. Neurologists argue about whether cognitive decline begins in your late forties (I’m 49, if you’re wondering) or your sixties. But whatever the details, the scientific fact is that pension policy is going to ask many people to take life-changing, complex decisions just as their ability to do so is waning.
Pointing this out isn’t ageist and it’s not unkind. It’s just an attempt to start an honest conversation about something that doesn’t get enough attention.
This is true of pensions policy in general. Politicians worrying about an election three or four years away rarely look decades ahead, and the voters they answer to don’t like to think about the distant future either. Especially when that future holds tough choices and awkward truths.
Progress towards addressing this is steady but limited. The government’s imminent Pension Schemes Bill should continue the slow journey towards “default decumulation pathways”, built-in nudges towards a safety-first use of retirement savings. Sensible enough, but probably not sufficient for a population that could have almost two million dementia sufferers by 2040. And probably not enough for widows and widowers whose deceased other half was the one who managed the money.
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In places, the pensions industry is starting to rise to this challenge. Aviva partnered with Age UK this month to propose a mid-retirement MOT, where 70-somethings get meaningful support to plan the next financial phase of life. Smart Pension’s Smart Retire tool looks like the sort of simplified offer many of us will need as we age.
Yet as so often in this area, all this takes place in the small, technical world of pension policy, far away from the general public who will, eventually, be affected. Without public engagement, policymakers and industry are left trying to design retirement systems that help people by stealth. That’s not sustainable.
In time, a more overtly paternalist approach is likely. A return to more widespread annuity purchase, albeit later in retirement than at the start, seems inevitable. What about “freedom”, though? Well, where’s the value in a freedom that you’re not equipped to use?
No one enjoys thinking about a future when they or their loved ones can’t quite fend for themselves, but ignoring the cognitive challenges of decumulation won’t make them go away. The sooner we start having hard conversations about human frailty and the limits to freedom the better.
James Kirkup is a partner at Apella Advisors
