The National Employment Savings Trust (NEST) has set out its new structure after the move away from compulsory annuities in the UK forced an overhaul of its at-retirement system.

The government-backed defined contribution (DC) master trust will now change from offering annuity-matching and cash-pot options to include a three-phased system with income drawdown.

Members will have the flexibility to choose their approach, but there will be a default that includes income drawdown which simultaneously supports a cash account and slicing off savings to fund an annuity purchase.

NEST said this would ensure its system met all its members’ requirements.

Its members, according to a recent survey, most want inflation protection, flexibility, savings that match longevity, market-risk protection, access to lump sums and the ability to pass on funds to dependants.

NEST currently has 2.1m members and more than £470m (€660m) in assets under management, with a public service obligation to accept any employer undertaking auto-enrolment.

At retirement, the system will transfer 90% of a member’s savings into the income drawdown fund, with the remaining 10% transferred into an accessible cash fund.

The drawdown fund will invest in an income-generating portfolio, which NEST said would provide a monthly retirement income.

NEST said it would look to design an investment solution that accounted for inflation protection, as well as sequential risk – the risk of members losing a significant proportion of savings in early years due to market falls.

The 10% cash fund is to run separately from the drawdown and will be invested in money market instruments to allow savers to take out lump sums without having to sell other assets.

NEST said the separate cash fund meant members could access 10% of their savings without undermining the sustainability of the monthly income provided by the drawdown fund.

After retirement, around 2% of the income drawdown fund will be siphoned off annually to finance an eventual annuity purchase.

The deferred annuity will be bought after 10 years in retirement and kick-in after an additional 10 years.

The master trust said it needed to consult with the industry to work out how the annuity would be offered, given that the UK deferred annuity market was not yet fully developed.

It said it had not ruled out a collective DC (CDC) system, whereby members pooled mortality risk, and annuities were provided from a central fund, but it acknowledged it had reservations.

However, it ruled out making monthly or annual deferred annuity purchases – akin to Denmark’s ATP’s approach – as this would prevent members from growing the annuity fund with contributions from the drawdown fund, as well as hinder flexibility.

When the annuity becomes active 10 years after purchase, the income a member receives will flatten out and provide a steady income until death. (see chart)

NEST said it had yet to work out whether the provision of income drawdown would be managed in-house or externally, but it did stipulate there could be a minimum fund size to enter the drawdown option – with preliminary discussions mooting the £30,000 mark.

CIO Mark Fawcett said the implementation timeline was still unclear and – given that the average pot size is approximately £200 – would not be required for some time.

According to NEST, members will be able to move out of the default option at any point prior to annuity purchase, while any remaining funds can be added to the annuity fund or passed onto dependants as inheritance.

“We have confidence the over-arching aim of a standardised strategy should be to provide a regular income throughout retirement, without requiring regular intervention by the member,” it said.

“To reflect differing needs at different phases of retirement, there should also be varying proportions of flexibility, inflation protection and longevity protection.”

Fawcett said the scheme developed an evidence-based blueprint to meet member needs and hoped it would stimulate the necessary innovation.

He added that, while its design had been considered, the technicalities – particularly around the deferred annuity purchase – needed further consultation and industry input.

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