The age of the annuity is over. It’s time to take responsibility for your own future, says JP Morgan’s Simon Chinnery.
Five years ago the very mention of the word “pension” sent almost every audience to sleep. So most financial institutions and publications just tried not to mention it. No more. Today, if you want to get the attention of potential clients (or readers), all you have to do is mention that you have something to say on pensions. With that in mind, I asked Simon Chinnery, head of JP Morgan’s UK defined-contribution division, to talk to us about the change in the industry.
In the last few years, pensions auto-enrolment has been rolled out across most firms; the compulsion to buy an annuity has been abolished (and annuity sales have collapsed); the death tax on pensions has gone (you can now leave the lot inheritance-tax-free to your children); and full pensions freedom – meaning you can take out any or all of your money whenever you want (after you turn 55) – has been put in place.
A revolution in pensions
These are huge changes. I wonder which one Chinnery thinks will bring the most change. His answer is pensions freedom. Now that annuities are not compulsory, people will have to make their own decisions about how to finance retirement. That is a game-changer for them – and for the industry, particularly given how long so many of us are now going to live. If you retire at 65 and live to
90, “that’s a long time not earning”.
The key point, says Chinnery, is that today’s world is a “lot more fluid” than it once was. Everyone wants different things from retirement – some will keep working, some won’t. Some want a cash lump sum, and some want to create an income. Creating products that fit these aims is the challenge for the financial industry.
I wonder if there aren’t two challenges here. The first is that, for Chinnery’s part of the industry, pensions have always been about helping people accumulate savings, and running them in such a way that on retirement they’ve switched out of equities mainly into bonds, which they can then sell to move straight into an annuity (a switch known as “the glide path”). The idea behind this is first that bonds are less risky (this is highly debatable, but remains accepted wisdom), and second that bonds match the needs of an annuity buyer (annuity prices are based on bond prices).
If the bond price goes up and hence yields and the annual annuity payout goes down, the annuity buyer is compensated by having a larger pot (due to the bond price rise). If the bond price goes down, the annuity buyer is compensated by the higher yield and higher annuity payout. But if people are no longer buying annuities, they don’t need to be switched fully into bonds by retirement. It just doesn’t make sense. That’s a problem, given that most defined-contribution pension savings are in “life cycle” funds, which are designed to switch investors into bonds as retirement nears.
The second problem is that the mainstream financial industry has little experience with helping investors with “decumulation” – drawing down and spending their savings. That’s because it hasn’t been their problem: when people bought their annuities, the problem was shifted onto the insurers. Chinnery agrees with this analysis. H
e is surprised, he says, at how slow the market has been to react to the changes. There’s been plenty of focus on those with savings in the £200,000-plus range, but little on those with £50,000-£100,000 who don’t want to pay for advice, but do want something “good enough and simple enough and transparent enough to be able to be used, probably as an alternative to a bank account”.
The perfect pension vehicle
So what works for this? The concept of life cycling is clearly “broken”, says Chinnery. It needs to be replaced with an investment fund that is well diversified and that “manages the various risks” that come with the various stages of an individual’s life cycle, but which doesn’t just stick their money in one asset class or in very low-risk assets – over a 30-year retirement, “you need some growth assets”.
The obvious problem, says Chinnery, is that “our industry is brilliant at over-engineering everything”. So right now, advisers are looking at default funds (the mostly life-cycle funds that 80% of those paying into a company pension default into) and thinking the thing to do is to make more defaults: one for those who think they want growth; one for those who think they will take cash on retirement; and one for those who might buy an annuity.
So “suddenly you have this bizarre thing where you’ve got multiple defaults”. That would be fine if the 20-, 30- and 40-somethings choosing these default options had the faintest idea what they wanted to do when they hit retirement. But most “have no idea”. What if they say they want to be in cash at 65, and so are put on that glide path, only to decide they’ll keep working until 70? “You could be parked in cash for five, six, seven years. Not a great place to be at the moment.”
So making multiple glide paths and multiple defaults when you just don’t know (and can’t know) the whole picture of a person is pointless “over-engineering”. Better surely to just own a good “multi-asset fund, that is actively managed between different asset classes and managing different risks, whether it’s inflation or interest-rate risk”, with a view to creating a fund that can replace your income on retirement.
If you want cash, you can then just cash in the units. “It’s not rocket science.” So the answer to every problem is a multi-asset fund? It is. If you don’t know what you want when you are saving for retirement, you probably want a multi-asset fund of the type just described (also known as a “target fund”). And on retirement? You probably want a multi-asset fund then too – for diversification and because they do “feature strongly in terms of income”.
That moves me to ask about income. I’m confused by the finance industry’s point of view. Surely for the purposes of retirement it doesn’t matter if the money you spend is capital, capital gain, or income? You’re in the decumulation stage – the whole point is to use the money saved in a working life to finance a non-working life. Chinnery agrees, but notes that it is mainly a problem of risk-aversion. Many retirees don’t overspend (as we all fear they will). Instead, fearing that they will run out of cash, they underspend.
The industry could find ways to help with that by offering perhaps some kind of insurance – encouraging people to use part of their capital to buy deferred annuities that kick in at age 80, for example, just in case. That makes some sense. Surveys show that if you ask people what they want from a retirement income, they say they don’t want an annuity – but still describe something with all the characteristics of an annuity.
Be afraid – very afraid
Chinnery seems quite relaxed about these changes. I wonder why he isn’t a little more scared. After all, we are entering an era in which hundreds of thousands of well-educated people with time on their hands will get access to their retirement savings and will have to take responsibility for taking care of it – and making it last for 30 years.
It won’t take long for these people to realise how much they pay for the average fund – multi-asset or not – and to figure out the difference those fees make to their returns, and perhaps even to start comparing their own retirement living standards with Chinnery’s. If I were the conventional financial services industry, I’d be terrified.
He isn’t. Why? Because, he tells me, their target-date funds (the multi-asset funds we’ve been discussing) have transparent and simple pricing. And because he thinks there are likely to be some price caps (these take the heat off the industry but are also almost always set at levels that don’t challenge their margins). But also because he doesn’t expect the industry to come under the kind of scrutiny I see coming. He reckons most people will want to be informed and will expect transparent pricing, but will also “just want to get on with being retired”.
Instead of spending hours a day worrying about it, they’ll want some kind of “default in-retirement” fund they don’t have to think about much. As long as people understand what they’re buying – and it’s the industry’s job to make sure they do – they won’t want to be “drowned in choice… I don’t think we need to be designing ultra-smart, really complicated things… we just need to listen to what people want.”
That sounds good and we leave it there. But we’ll be watching what comes next closely: after all, the financial industry has (as Chinnery knows) more of a history of creating products that work for it, than products that work for savers.
What is a defined-contribution pension?
A defined-contribution (DC) pension – also known as a “money purchase scheme” – is the type of pension that most of us have. You save up and invest over the course of your working life (often with your employer matching your contributions) and hope that you have enough money at the end to fund your retirement. In short, if you have a DC pension, then the investment risk is on you.
With a defined-benefit (DB) pension – which is rare outside of the public sector these days – the employer guarantees to pay a certain annual income on retirement, based typically on length of service and salary. With a DB pension, the investment risk is on the employer, which is one reason why most private-sector schemes are now closed.
Who is Simon Chinnery?
Simon Chinnery joined JP Morgan Asset Management in 2005 and became head of its UK defined-contribution division in 2012. Prior to that he spent five years at ABN Amro, where he was director of UK institutional client services.
He has also held positions at Schroder Investment Management and Gartmore, among others. He began his career in the City in 1983, working as a stockbroker. Chinnery is also an artist – you can view his paintings online at simonchinnery.com.