Providers will soon be required to offer pension savers guidance towards their optimal retirement income choice, says Steve Webb
Freeing people to do what they want with their pension savings, rather than forcing them to buy an annuity, has proved a very popular move. But that freedom means people now have difficult choices to make and need help in making a decision that is right for them.
Those willing and able to pay for financial advice are in general able to benefit from the new freedoms. However, The Pensions Regulator has become increasingly concerned about the fate of ‘unadvised’ pensioners and is keen to help them make the right choices about what to do with their pension pots.
That’s why an initiative called ‘default investment pathways’ will be launched later this year. New rules will require pension providers to guide unadvised savers when they are deciding what to do with their pension pots at retirement. The rules are designed to help around 100,000 people a year achieve better pension outcomes.
At the moment, once you reach the age of 55, you can take your money out of your pension pot. A quarter can be withdrawn tax-free, while the rest is subject to income tax. People often want to withdraw their tax-free lump sum but are happy to leave the rest to go on growing
One way of doing this is to move the balance into a ‘drawdown’ account. However, when you do this, you have to decide how that balance is going to be invested over coming years: whether, for example, you are going to target high investment growth, which will entail taking on a fair bit of risk, or be much more cautious, which will involve little or no risk to your capital but achieve much lower returns.
One problem is that many people have been sleepwalking into leaving their pension savings languishing in cash. Without them really thinking about it, the balance of their pension savings has been placed in an investment that yields little or no return, although their capital is safe.
The trouble with this is that once you factor in inflation, the spending power of such savings declines year by year. That might not matter too much for a year or two, but if you are going to keep your money invested for retirement for two decades or more, you really don’t want it to be stuck in an investment offering little or no return over that period.
To tackle the problem, providers will soon be required to offer savers a choice of four relatively simple ‘investment pathways’ for making best use of their pension pots in retirement:
Option 1: For those who don’t plan to touch their money in the next five years
Option 2: For those who plan to use their money to set up a guaranteed income (annuity) in the next five years
Option 3: For those who plan to start taking their money as long-term income over the next five years
Option 4: For those who plan to take out all their money over the next five years
Once a saver has chosen the option that best matches their plans, the provider will invest their pension money in a mix of assets designed to achieve their goals. Savers will remain free to choose between the different investment offerings available from a provider, but providers will be required to give prominence to the simpler approach.
Pension providers will also be required to do more to encourage pension savers to shop around when they choose a drawdown provider. At present, the vast majority of people who save with a pension company choose a drawdown product from that company, even if it doesn’t offer the best value available on the market. Just as shopping around for an annuity can help people get a better rate, shopping around for a drawdown account can help them track down a better-value product.
Although there is no substitute for personalised financial advice where possible, it is to be hoped that the simplified guidance from pension providers will help those who are not taking such advice to end up in an investment that is broadly right for them. Meanwhile, the exhortation to shop around should help retirees bag a better-value drawdown product.
Steve Webb is a former pensions minister and director of policy at Royal London. He is currently a partner at consultancy Lane Clark and Peacock.