The outbreak of Covid-19 has had an enormous impact upon financial markets, and as a result, the retirement savings of DC members in the UK and abroad. What can we learn  from the experience in Australia?

In Q1 2020, we witnessed extraordinary levels of market volatility, a sell-off in risk assets, a tightening of liquidity, increased transaction costs and fund suspensions. As the reality of Covid-19 and mandatory lockdowns sets in, a lot of members may face smaller pension pots, reduced working hours or even job loss. Here, I will look at how DC schemes can assist their members in challenging market conditions and the effectiveness of these policies to date.   

As we know, DC schemes are designed to help members save for retirement throughout their working lives. Amidst market chaos, it’s important to remind members that saving for retirement is for the long haul. Making “knee-jerk” reactions to market noise, such as selling out of growth assets, can have a significant (negative) impact upon retirement outcomes. 

What have others done? 

In response to Covid-19, the UK and a number of countries have introduced regulatory guidance and innovative policies specific to retirement savings. These range from improving online procedures to address operational disruptions, warning members about scams and cyber-attacks, communicating the consequences of switching, and facilitating early access to retirement savings.  

In April 2020, Australia introduced the Covid-19 Early Release Scheme (ERS), which allows eligible members to access their retirement savings early, specifically:  

• A$10,000 for the financial year ended 30 June 2020; and  
• A further A$10,000 for the 2020/21 financial year. 

As of 2 August 2020, over 3 million applications for ERS had been received, with about A$30bn worth of applications approved. While the value of applications seems large in absolute terms, it represents less than 1% of total superannuation assets in Australia. However, for some funds, the impact has been more pronounced.  

Hostplus, for example, is one of Australia’s largest industry superannuation funds with around A$48bn of assets. Its membership is concentrated in the hospitality, tourism, recreation and sporting industries, all of which have been significantly disrupted by the pandemic. It has processed over 360,000 ERS applications and paid out A$2.6bn, which represents about 5% of assets.  

What are the hidden challenges of going down this path?  

Providing members with early access to their retirement savings might be a short-term solution, however there are many impacts which need to be considered, such as:  

1. Members may crystallise losses
   • Members could lock-in losses and give up potential rebounds by redeeming their investments to fund early withdrawal payments.  
2. Members may be unable to rely on compounding returns to the same extent
   • As members make early withdrawals, they reduce their future earning capacity as returns are made on a smaller pool of assets. To make up for this shortfall, members could consider making additional voluntary contributions as and when they are able to do so. 
3. Members may incur higher than normal transaction costs 
   • For some asset classes, the cost of buying and selling is elevated by historical standards. If members make early withdrawals, they are likely to incur high transaction costs and reduce the value of their savings.  
4. Members may have inadequate savings at retirement
   • Early withdrawals could result in members being unable to fund their retirement from personal savings.  
5. How do pension schemes communicate and engage with members effectively? 
   • DC schemes would need to communicate and engage with members on the consequences of making early withdrawals, particularly with younger members who might underestimate its impact on retirement outcomes. 
6. How do you ensure withdrawals are used appropriately? And what is “appropriate”?
   • Although the intention for early release schemes is for members to use these withdrawals on essential day-to-day expenses, how do DC schemes ensure members do so? Should members have the right to make their own financial decisions about their own savings?
   • In Australia, a recent study of 13,000 members who were provided with early access to their retirement savings, shows that 64% of spending has been on discretionary items such as clothing, furniture, gambling and alcohol.  

Is there a happy medium? Perhaps it’s already here!  

In 2018, Nest, the workplace pension set up by the UK Government, introduced its “sidecar savings model”, whereby a liquid emergency savings account is linked to a traditional DC pension pot. Members build up their emergency savings over time (and their financial resilience) while also saving for the future. In periods of financial distress members can access their emergency savings without impact their retirement outcomes.

As the benefits afforded by the UK’s Coronavirus Job Retention Scheme wind down, we must consider how those financially affected by Covid-19 can remain afloat throughout this difficult period. In my view, making early withdrawals from retirement savings should be a last resort for all members given the potential repercussions of doing so. Should the UK decide to implement a policy like Australia’s, it is more important than ever for DC schemes to communicate and engage with their members and to think about linking wider financial wellbeing with pensions should as in the NEST example.