One of the big conversations within the U.S. retirement industry is the need to shift the focus of the system from simply the accumulation of savings to the provision of lifetime retirement income. We’re not alone in thinking about that question. A recent white paper out of the UK offers some interesting food for thought.
A UK approach to lifetime retirement income
The paper is called “The future of retirement; a retirement income blueprint for NEST’s members” and was produced by the National Employment Savings Trust (a plan established by the UK government as part of a program to enable auto–enrollment and address the coverage gap there.) Their proposed approach is based on three building blocks, each of which addresses a different aspect of a retiree’s needs:
- An income drawdown fund. This is retirement income as we usually think of it.
- A cash lump sum fund. This fund would be used to meet unexpected cash requirements, without taking from the income drawdown fund.
- A later life retirement income fund. This fund is used to protect against living longer than expected (the longevity tail.)
NEST’s blueprint follows from a fairly extensive consultation process and a substantial amount of research into consumer needs and attitudes. The conclusion drawn from that research process include the primacy of retirement income over ad hoc access to cash; the importance of defaults; and so on. The paper also establishes a number of guiding principles that underpin the three–piece framework: these principles include, for example, that income should be stable and sustainable, and that providers should offer flexibility and portability wherever possible.
What does this tell us about the U.S.?
Let’s take a look at the current U.S. landscape against this three–part framework. The income drawdown fund is where the main focus of attention currently lies; even shifting the mindset from one of “how much do I have saved in my retirement plan?” to “how much lifetime income will that provide?” would be an important step forward.
The second building block—the cash lump sum fund—is often part of the thinking, but it’s not usually explicit. It tends to crop up as an observation about the need for liquidity in case of unexpected health care needs, for example. One lesson we may be able to draw from NEST’s blueprint is the value of calling out the cash lump sum fund as a separate pool of capital.
And the later life insurance fund directly attacks one of the toughest elements of the retirement planning challenge: how to handle longevity risk. NEST suggest concentrating this fund on the period starting at age 85, which, in effect, means regarding it as an insurance policy against the possibility of a longer–than–average life. Without such an insurance policy, the flexibility of the drawdown fund is constrained because money needs to be set aside against the possibility of a long life. It may offer an answer to the problem of where annuities fit: in theory, retirees should prefer to have a large part of their assets in the form of a lifetime income—but in practice, purchasing an annuity is a difficult decision for a number of reasons (the exposure to the insurance company, the inflexibility and so on.)
The blueprint offered by NEST has been well–received in Europe, even receiving an Innovation Award at the recent 2015 World Pension Summit held in The Hague, Netherlands. It gives us some food for thought here in the U.S., too.