By Louise Farrand, executive director of the DCIF
Nest was set up by the government in 2010, with a Public Service Obligation to accept any employer which wants to use it for auto-enrolment. With over 14 million members and £50bn of assets under management, the pension scheme has grown exponentially since it was created. Now, Nest is addressing an all-important challenge, which has long been considered one of the trickiest problems in finance: how to give its members a sustainable retirement income.
Nest’s believes that trustees’ fiduciary duty does not stop in retirement. Instead of leaving members to grapple with complex financial decisions, trustees should continue to help people to avoid the many pitfalls which could await them in later life, from investment risk to running out of money too early. The scheme published its blueprint for a retirement income strategy in 2015.
Gareth Turner, Nest Invest’s head of strategic projects explained the scheme’s thinking to the DC Investment Forum in a recent podcast episode.
Nest’s members are mostly low to moderate earners, with an average income of £24,000. While the state pension will make up a large chunk of their income, they will likely also need to rely on their workplace pension savings. However, most members are unlikely to be willing to pay for financial advice – nor will they be attractive to advisers.
Many Nest members save into their pension scheme aiming for a steady income stream through retirement. Giving members this assurance will also help them to avoid some of the problems that retirees in other countries have experienced. For example, Australia’s superannuation savers are often more frugal than they need to be in later life, fearing they may run out of money before they die.[1]
Annuities might sound like the obvious solution, but they are unpopular among consumers. Just 39% of over 50s in the UK believe they are best for providing a guaranteed, stable income for life, according to research by Standard Life.[2]
Despite annuities’ poor reputation, Nest’s year-long research process with its members showed that people want something very similar. On the podcast, Gareth Turner told the DCIF: “Our members want to use their savings for a lifelong income akin to a wage replacement. Because they’re not necessarily going to get financial advice, they want a lot of support from their scheme to provide them with that lifelong income.”
Another important takeaway was that members value flexibility early in retirement, but later, they are keen to have a secure income for life and are willing to make financial trade-offs to make this possible.
Nest’s challenge was clear. How could they give members a lifelong income and a clearly communicated retirement pathway which does not require them to make any complex decisions?
The retirement blueprint
Nest has created a ‘retirement blueprint’, which will give members a smoother path from their working lives into retirement.
The idea is that from State Pension Age, members will start receiving a regular income, while their money remains invested. Later in retirement, around the age of 75, Nest will bulk-buy longevity protection for a cohort of similarly aged retirees, in an insurance transaction akin to a buy-in. The pension scheme would retain responsibility for the customer experience and administration and would buy deferred annuities in bulk from an insurer. Then, when they reach the age of 85 (or thereabouts), the annuity would pay out for the rest of the member’s life.
“From a member’s perspective,” said Turner, “What they would see the whole way through is a sustainable income provided to them by Nest and in the background, we would be blending strategies together to deliver that income to them.”
Conversations with insurers
Inevitably, a pioneering project like this will come with plenty of details to iron out. Initially Nest will work with one insurer, as it perfects the design of its process. “As member and asset flows build up, there will be a question as to whether we could better meet our members’ needs through a panel of insurers – but that is a long-term consideration,” said Turner.
It is important to Nest that retirees can change their mind or opt for an alternative way to use their retirement savings. The pension scheme will ensure that members can dial up or down the proportion of money they have invested in the early years of their retirement. Nest wants to work with its chosen insurer to find a way of providing transfer values for members where their funds have been invested in the bulk deferred annuity.
There are several other as-yet unsolved conundrums which Nest is seeking to address in its scheme design with insurers. What happens when a member buys an annuity and dies shortly afterwards? Who will manage the assets for the deferred annuity: the insurer, Nest, or an external asset manager? Crucially, how can the pension scheme make sure it is getting value for money from its insurer? “These are all points we need to work through with our chosen insurer,” explained Turner.
Member communication is another vital ingredient, as Nest embarks on the ambitious journey of engaging people throughout their lives. “All of the thinking about how we engage with our members, the communication and user journeys, we will need to go through in the co-design phase with our insurer,” said Turner, adding: “Language is important to members – we need to talk about the benefits, the certainty it provides and the protection they receive against the risk of outliving their savings. Those are the features we need to communicate well.”
What’s next?
Nest is working through a procurement process to consider the feasibility of this approach and choose an insurer with a view to appointing one towards the end of 2025. Once the insurer is in place, Nest envisages at least a year of working together to build a proposition, before launching it to members.
Ultimately, Nest is hoping not just to pioneer a new UK model for retirement, but to share what it learns with the rest of the world. Turner says: “We’d be really happy to see the lessons that are learned through the design process applied to other defined contribution schemes in the UK and around the world.”
[1] Why Many Retirees are Underspending, Vanguard Australia, September 2023: https://www.vanguard.com.au/personal/learn/smart-investing/retirement/why-many-retirees-are-underspending
[2] Annuity rates reach highest levels in two decades – but half of over 50’s still don’t fully understand how annuities work, Standard Life, September 2023: https://www.standardlife.co.uk/about/press-releases/annuities-misconceptions