Adrian's Corner -
Don't mention the pot size
19 October 2015
Adrian Boulding - Retirement
Strategy Director at Dunstan Thomas
||I was fortunate recently to attend a lecture
by Professor Robert C Merton, the nobel
prizewinning economist and resident scientist at
Dimensional Fund Advisers in the US.
is critical of the way that many DC schemes
communicate with members and was at pains to
point out the damage we do by telling members
the size of their DC pot and recent year's fund
In a very academic way, he distils pensions savings
down to its basic rationale, the goal of providing a
replacement income after our time in work comes to an
I have to agree he has a point here, and one
we've been forgetting recently with all the excitement
over George Osborne's pension freedoms and the ability
to cash it all in on reaching the magic age of 55.
We could learn something from the DB world here. For
as many DB trustees have found, under certain economic
circumstances your assets might have been going up but
your funding position was getting worse because the
value of the income streams the DB scheme has promised
are going up even faster. The correlation between pot
size and what pension that pot will provide is far from
The message is that by focussing
on the pot size, we are sending out irrelevant and
potentially mis-leading information to the consumer.
Unless we turn their focus to the real desired outcome –
a replacement income in retirement – we cannot hope that
they will make sensible decisions.
need to make decisions when they are no longer on
target, which generally means they are part way through
saving and it’s becoming apparent that the projected
outcome is likely to fall some way short of what’s
desired. For many years I have followed the Turner
Commission mantra of three broad choices, which were
presented back to the then Government by Adair Turner as
“save more / work longer / pay higher taxes”. Of course
the Pensions Commission was looking at the whole
population, and for an individual the third option of
higher taxes is not really a choice, unless they can pay
extra national insurance to top up an incomplete State
Professor Merton introduced a third
option more suitable for individuals – “take more risk”.
In many ways this is highly appealing, as it doesn’t
involve the reduction of immediate consumption that
“save more” requires or the deferment of the leisure
time that comes with retirement that “work longer”
involves. Simply move your investment to higher risk
funds and your expected outcome is back on target.
This underlines the difficulty of deterministic
projections. As the Professor pointed out, if you want
to use higher risk investments, then as part of the plan
then you have to be aware of the potential downside and
have an accepted course of action for when the potential
risk is realised.
All of this would have been
good advice if pensions were just meant to provide a
pension. But the hugely popular reforms introduced by
George Osborne have complicated that somewhat.
Nevertheless the same output focus can still be adopted.
The target is likely to be a lump sum at retirement, a
few more lump sums along the way to provide for holidays
etc and a further lump sum at the end to provide an
inheritance. Plus of course a regular monthly income
with hopefully a degree of inflation protection to
maintain living standards.
In reality the cost of
the monthly income is likely to overshadow the others,
as most people are in a deficit position with inadequate
savings and from a Maslow needs perspective that regular
income is pretty essential whilst those lump sums are
just icing on the cake.
So I came away convinced
by Professor Merton’s arguments. We should focus on the
income stream required in retirement. And as there’s a
huge difference between wealth and permanent income, we
might be wiser not to mention the pot size to pension