By the time you read this, there will be less than four months to go until the regulator’s investment pathways will need to be offered to the roughly 30% of consumers moving their defined contribution (DC) pensions into drawdown without consulting a regulated financial adviser.
This may catch quite a few clients with advisers, who are either starting drawdown or more likely moving more funds into drawdown without having recently talked to their adviser.
From 6 April 2020, drawdown product providers will need to implement the Financial Conduct Authority (FCA) prescribed investment pathways to help consumers make the most of their retirement savings by lining up their savings access needs with the right decumulation choice as follows:
Option 1: I have no plans to touch my money in the next five years
Option 2: I plan to use my money to set up a guaranteed income (annuity) within the next five years
Option 3: I plan to start taking my money as a long-term income within the next five years
Option 4: I plan to take out all my money within the next five years
The FCA should be commended for trying to create a ‘robo-guidance’ solution to the problem of unengaged retirees – a third of whom default into their existing pension provider’s drawdown policy and a third of these defaulters have their savings plonked into cash or cash-like assets today. As advisers will know well, leaving money festering in cash funds for long periods seriously erodes its purchasing power.
Pathways force the saver to decide what they want to do with their money once they can access it at age 55.
Broadly, (in Option 1) they may decide that they are going to retire much later and will not need to access the money for five years or more.
Or, Option 2 steers them to purchase an annuity based on the consumer’s desire to secure a guaranteed income in retirement.
Option 3 suggests that they want to use the money for drawdown, but an investment solution still needs to be found which optimises income long-term; while Option 4 is the active choice to move all the pensions savings out within the next few years ready to spend.
Even the unengaged will make a decision because they won’t get their tax-free cash out until they do.
Their drawdown provider must then offer one ready-made investment solution for the option chosen by the saver.
However, what investment pathways fail to allow for is splitting of the pot so that a portion might be earmarked to meet a particular short term goal (pay for a new car or expensive holiday), while the rest is retained to provide a long-term income at the point of actual retirement in say 10 years’ time even though the consumer research tells us that’s precisely what many people want to do.
Behavioural insights
To properly understand the varied circumstances which consumers find themselves in as they go into decumulation, it’s worth reading the Behavioural Insights Team (BIT) research document ‘Increasing comprehension of investment pathways for retirement’.
In BIT’s study of 1,468 54 to 70-year-olds in the UK conducted last year, it found that 33.7% of the sample had DC pots worth under £30,000 in total. We can only speculate how many of these people with relatively small pots are ‘unengaged’ precisely because they are looking elsewhere for most of their retirement income.
One in five (20.5%) didn’t have a clue how much they had in their pension(s), according to the BIT study. Of this nationally representative group of Baby Boomers, nearly a third (29.8%) wanted guaranteed income, while 16.5% stated they wanted to generate a retirement income without purchasing an annuity. A fifth (20.8%) wanted flexible access to their savings; while 6.9% wanted to take some as soon as possible and leave the rest invested and 5% wanted to leave all their pension invested with a view to handing it on to family members over time.
The investment pathways are a crude attempt to replicate what an IFA would look at together with a client taking their tax-free cash out and moving the other 75% into drawdown.
While the client is naturally focused on getting their hands on the cash to meet a pressing short-term need, the adviser can lift their eyes to the longer horizon and make sensible plans for the portion left invested. While the investment pathways are necessarily broad brush, they are an improvement over the current position where many savers end up leaving their money invested in cash for years before returning to look at their pension again.
The implementation of investment pathways is in some ways, therefore, an interesting test case into what can be achieved in ‘robo-guidance’ through FCA-rubber stamped customer journeys. However, it also highlights that you can only go so far in robo-land before you need to turn to the services of a financial adviser to make a fully researched and fully personalised recommendation which recognises all the personal circumstances of each would-be retiree.
Asking the right questions
For an adviser will be able to ask the questions which might uncover the reality of what that DC pot needs to achieve.
Is it the only long-term personal savings pot available to the customer? Or are they looking to downsize their home; tap their small Buy to Let portfolio; or are they waiting for an anticipated inheritance, or plan to sell a business before contemplating retirement? What attitude to risk can they adopt?
It’s that thorough fact find which uncovers the best options for their DC pot(s). Only an IFA can uncover the real financial needs of a person, based on a thorough understanding of their circumstances. That same IFA is likely to be best placed to help DC pension potholders make the right choices in decumulation and the right investment selections in line with those decumulation choices.
Only time will tell whether the introduction of investment pathways will increase or decrease the demand for financial advice.
On the one hand, drawing consumer attention to the options and forcing them to choose should mean more will appreciate that they need a deeper level of help. But on the other hand, consumers may feel that the previously dark arts of retirement have been clarified for them by FCA and they can simply plough their own furrow and save the cost of advice.
I’m hoping that the former wins out, as the last few years before retirement are complicated and advisers have much to offer in that vital period.
Adrian Boulding is director of retirement strategy at Dunstan Thomas