The FCA has delayed the introduction of new pension investment pathways for those moving into drawdown until February 2021 in the wake of the coronavirus pandemic. Prior to the outbreak, Sam Barrett examined the retirement routes.
Greater flexibility around taking an income from a pension also comes with greater risk. Unlike an annuity, which will last as long as you do, there’s a danger that without the right investment and income decisions, your pension pot won’t stay the course.
Aware of the risks, the Financial Conduct Authority (FCA) conducted a review, which looked at how the market has performed since pensions freedoms were introduced in 2015. This highlighted several shortcomings around the investment choices people were making in drawdown.
In particular, the regulator found that a third of those who had moved into drawdown without taking advice had their pension pots in cash or cash-like assets. While this might be suitable if they were looking to cash in their pension or use it to buy an annuity, this low-risk investment approach has high penalties for anyone taking a long-term view on drawdown.
The FCA calculated that someone taking income from their pension over a 20-year period could increase their annual income by 37% by investing in a mix of assets rather than being solely in cash.
A clearer path
Option 1: “I have no plans to touch my money in the next five years”
To ensure that people make more appropriate investment decisions, and don’t inadvertently forfeit significant amounts of retirement income, changes are afoot.
The Financial Conduct Authority (FCA) had originally decided that from August 2020 pension providers would be required to offer ‘investment pathways’ to anyone moving into drawdown who hasn’t taken financial advice. However, following the coronavirus pandemic, the introduction has been deferred until February 2021.
Under the pathways, people will be offered four different options for how they might want to use their drawdown pot over the next five years, from leaving their money untouched through to withdrawing it all. Based on their choice, the provider must then present them with an appropriate investment solution.
The idea has been well-received by many in the pensions industry. “This is incredibly positive,” says Fiona Tait, technical director at Intelligent Pensions. “Being able to work out longevity and how to manage a sustainable income in retirement is not easy. In many cases it’s also likely that, up until this point, someone will have been making investment decisions on their behalf, whether through a final salary scheme or a managed or default fund.”
As well as signposting the pathways, drawdown providers must also issue additional wealth warnings to anyone keen to stick with cash. Under the FCA rules, they must ensure that anyone investing wholly or predominantly in cash has actively chosen to do this, and warnings will be issued to those already in cash as well as those looking to major in it for their drawdown pot. “It is a good idea,” says Paul Waters, head of strategic digital solutions at Hymans Robertson. “By taking away the investment decision from the individual, it will avoid them ending up in cash when they would be better off in other investments.”
Solutions taking shape
Option 2 : “I plan to use my money to set up a guaranteed income (annuity) within the next five years”
With the introduction of investment pathways a few months off, providers are still firming up what they plan to offer. “We will have a single low-cost, multi-asset fund for each option,” says Richard Kelsall, senior propositions manager at Aviva. “We’re still working through the exact make-up of each fund, but they will be available when the new rules come in.”
Royal London is also working on its pathways, anticipating that they will be made up of a combination of portfolios and funds. Similarly, at Aegon, pensions director Steven Cameron is expecting to see four investment solutions matched to the retirement path someone is taking. This, he says, would include an investment in long-dated gilts for anyone considering an annuity; largely cash for those looking to take all the money; and more long-term investments for those intending to use drawdown for longer through one of the other two options.
Although Cameron doesn’t expect to see anything particularly innovative in the investments, he does believe providers “need to stress it’s not a ‘happy ever after’ solution, but this will also give us room to explain some of the caveats and ideas such as risk.” He adds: “This could potentially engage people with their investment choices and may lead to more taking advice.”
Option 3: “I plan to start taking my money as a long-term income within the next five years”
The pathways may represent a giant step forward, especially for those whose pensions may have snoozed in cash for the long term; but, as with any simple solution to a complex problem, there are limitations.
Fitting everyone in drawdown into one of four investment solutions is a fairly blunt approach. Robin Nimmo, proposition strategy and insight manager at Royal London, is concerned that by making the process so simple, it won’t suit everyone. “The pathways don’t take into account an individual’s attitude to investment risk. They’re likely to be suitable for a balanced investor, but they could be too risky for a cautious investor and too cautious for an adventurous investor.”
The blanket approach to risk is also a concern for Kelsall. “We can only present a customer with one investment solution for each pathway so we will need to decide what level of risk each should carry. If they want to take more or less risk, they will need to move out of investment pathways and select their own funds.”
As well as glossing over the idea of risk, the pathways also sidestep other important factors such as the level of income someone might want to take, or their life expectancy. “Many people will benefit from the pathways, but providers need to be careful they don’t lull them into a false sense of security,” adds Cameron.
Follow your own path
Option 4: “I plan to take out all my money within the next five years”
For anyone who’s taken an active approach to selecting their pension investments, the four-sizes-fits-all approach is unlikely to appeal, notes Waters. He further adds: “It is likely to be far too prescriptive for some investors. However, the pathways could provide a useful reference point, even if you do decide to do something different.”
Whether or not the investment pathways help to shape your drawdown decisions, their introduction could potentially benefit your finances in another way. As part of its review, the FCA found that charging on drawdown plans was confusing, difficult to compare and, with charges ranging from 0.4% to 1.6% a year, uncompetitive in some cases too. To address this, from August, anyone in drawdown will receive annual information on all the charges they’ve paid in a simple pounds and pence figure. This will create greater transparency around the cost of plans and lead to more competition in the market.
On top of that, while the regulator hasn’t gone as far as laying down the law on how much providers can charge for their investment pathway solutions, it has stated that they should provide value for money. In theory this should drive competition across the market, which is good news for those approaching or in drawdown.
So, while the investment pathways might not net you the 37% uplift that someone slumbering in cash could unlock, their introduction could certainly benefit your retirement income plans.
Data shows advice and asset mix needed
30% of consumers enter drawdown without taking financial advice
94% of these non-advised investors don’t shop around and take their pension provider’s drawdown plan
33% of these non-advised investors have their pension pot in cash
37% higher annual income over a 20-year period if invested in a mix of assets rather than just cash