Effective financial education for those considering retirement.

3rd August 2015

The most radical pensions overhaul in nearly a century has arrived! These changes offer employees in a defined contribution scheme (DC) who are aged 55 or over, greater flexibility in how to access their pension. But without the right financial education, employees could be left incredibly vulnerable to making poor and costly decisions.

Many employees start working life with only the most basic financial knowledge, so an effective financial education strategy should take account of this and support them throughout their career. In the years leading up to retirement and at the point of retirement, it is even more important due to the choices an employee can now make about their retirement income options.

Where to start

A good starting point is to consider what the appropriate age is to begin this process. In our experience, 45 has become the new ‘latest age’ to begin planning for retirement. It’s a move from the traditional idea of educating those just a couple of years away from retirement but is more effective as given the new rules, choices need to be made much sooner.

Gliding towards retirement

For example, an area which is a cause of concern is that employees need to give greater consideration to their retirement ‘glide path’. By ‘glide path’ we mean a chosen investment route that will take an employee up to the point of retirement and potentially beyond. It is a formula that defines the asset allocation mix of a pension savings fund based on the number of years to the target date, usually the anticipated date of retirement. The glide path typically creates an asset allocation that becomes more conservative or takes less investment risk (i.e. includes more fixed-income assets such as bonds and fewer equities) the closer a fund gets to the targeted retirement date.

However, our experience tells us that employees find selecting funds for their pension confusing at the best of times, and most choose to invest in the default fund provided by their workplace pension. Prior to the pension changes, a ‘life style’ approach was used and the asset mix in the default fund changed as their retirement date approached, for example including more fixed-income assets in their late career. This is because the default option assumed that an employee would buy an annuity in the future. Many companies are realising this will not now be the choice made by many and consequently want employees to look at their glide path at least ten years before their anticipated retirement date because if they want to choose another form of retirement income such as drawdown, they may wish to address their fund selections at this point, in other words pick a more suitable glide path.

This is very important as the new pension changes have made more retirement income options accessible to all pension savers, for example taking a whole pension fund as cash or buying an annuity, going into drawdown or a combination of some or all of these. If employees have selected a default fund which is geared towards an annuity purchase at retirement and they are now considering drawdown, they should consider other fund choices; for example; exposing them more to equities and less to fixed-income assets. And of course, if this is the case, employees will need financial education in order to understand this to have confidence to make their selections.

And it’s not just about pensions! Employees now have to think beyond pensions and consider all savings such as ISAs, share schemes and any deposit accounts because tax efficient withdrawal of cash from pensions or any other savings to use in retirement should be an important consideration.

Post financial education

Of course, once employees have had financial education and are at the point of retirement, they will want to know ‘what they need to do next’ and ‘how do they do it?’ This is where regulated advice can help employees make the right choices at retirement and prevent costly mistakes from being made.

Further coverage can be found in Employee Benefits.