PTL Blog

DC Defaults: Knives or Forks?

Posted by Richard Butcher on Jul 2, 2015, 9:00:00 AM

Knives_and_ForksOne of the issues currently tying trustees and IGCs in knots is how to redesign their DC default investment strategies in the wake of April’s Freedom and Choice changes.

In the past defaults were fairly easy to design. Although we couldn’t tell with any certainty when a member was going to retire, we could take a pretty good stab at it and, what ever age they went, we knew they would be taking an income for life in some form or another. Everyone was broadly in the same boat and so one universal default investment strategy was good enough.

April changed both of these important components. Members can go at any time of their choosing after age 55 and they can take their entire pot as cash in one go or in a series of payments.  As a result we need to (a) consider redesigning our defaults as they are less likely to be appropriate and (b) make some decisions about how the default should look in this brave new world.

At the heart of the second of these is the argument about knives and forks.

A knife investment strategy will look fairly similar to your current default. It will be a single strategy designed to be optimal for an average member and applied to all. In arriving at it, you, or your consultants, will make assumptions about when and in what form the member will take their pot. It will, necessarily, be suboptimal for any one who strays from the average model either in timing or form of pay out. 

A fork investment strategy will look exactly the same as a knife strategy during the accumulation phase (DC Defaults: The four phases). It, however, takes a completely different journey during the consolidation phase. In fact, to be more accurate, it could take any of a number of different journeys during the consolidation phase.

A fork strategy is a more granular strategy that makes an additional assumption about the member.  At the point that consolidation begins it will bucket the membership into three categories: those likely to take cash, those likely to take drawdown and those likely to go straight to an annuity – the split being based on projected pot size.  The default is then different and designed to be optimal for each bucket.

As with a knife strategy, the fork strategy will be suboptimal for some members. This will particularly be the case in relation to timing but also for those members who behave otherwise than is anticipated for the bucket they are in. Its aim, however, is to be more relevant for most members. 

Neither knife or fork strategies are right or wrong. They both risk producing a suboptimal outcome – but that is the nature of a default. Which you go for will depend on your personal preference. 

For more information about DC schemes CLICK HERE

Topics: Defined Contribution, IGCs

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