Gareth James: Drawing the default fault lines

Gareth James looks at the default drawdown investment pathway options currently being discussed by regulators and politicians

The decision making process at the point of retirement has become significantly more complex since the introduction of the pension freedoms three years ago.

A majority of new retirees are now shunning annuities and many in occupational funds are avoiding the ‘scheme pension’ option to take advantage of the reforms.

Hundreds of thousands of retirees are potentially wrestling with difficult choices, which will include:

  • Whether the time is right to access their pensions;
  • How they access their pensions – UFPLS, drawdown or tax-free cash only;
  • How much they withdraw when they do access; and
  • Where to invest the remaining funds, whether those are inside or outside their pension, after they’ve been accessed.

In its interim report into the Retirement Outcomes Review, the Financial Conduct Authority (FCA) proposed many remedies for the issues it recognises as present in the retirement space. One was aimed squarely at dealing with this complexity in the decision making process – default investment pathways.

The FCA said: “Once a consumer decides to purchase a drawdown product, or they are moved into drawdown to access their tax-free cash, providers could be required to offer them default pathways based on retirement outcomes chosen by the consumer.

“Consumers would be free to choose an alternative investment strategy if they wish to do so.”

Default thinking

More recently the Work and Pensions Committee (WPC) picked this up as a potential solution: “We recommend the government takes forward FCA proposals to introduce default decumulation pathways. Any provider offering drawdown would be required by FCA rules to offer a default solution that is targeted at their core customer group.”

After the report was published there was some debate over the exact meaning of this recommendation.

Was it a default into drawdown itself? A default level of withdrawal? A default investment pathway? The WPC has now confirmed that the scope of its recommendation is limited to the investment pathway.

This limited scope has good and bad points.

It’s positive because there are strong arguments for providers not being required to default savers into retirement at a particular age, and for not defaulting them into a particular level of income.

Even with an opt-out, the risk of savers being defaulted into potentially irreversible retirement ‘choices’ is too great. It would also go completely against the intent of the pensions freedoms themselves, giving savers choice regarding the withdrawal of their funds from their pension.

Less positive is the issue that a default investment pathway does nothing to help individuals with the when; how; and choice of pension access – which for many will have a greater impact than investment choice.

It’s also not clear how the default would work in situations where savers had put their investment strategy in place many years before entering drawdown.

If a provider is required to offer a default investment pathway, and these individuals miss the opt-out – bearing in mind that a fundamental principle of automatic enrolment opt-out is that people do miss it – the results could be catastrophic.

A basic issue with the proposed solution is that it is transactional in nature. By that I mean the regulatory measure is intended to kick in at the point the individual goes into drawdown.

This fundamental transactional problem is present in much of the regulation relating to drawdown. It arises because it was built on foundations which were built for the single point of purchase which applies to annuities.

Part of the package

Default investment pathways will help some, so is an idea I support if it is implemented appropriately. But it must form part of a package of support which recognises that retirement is no longer transactional, but is a journey that will last decades.

Wider regulation also needs to reflect this. Sadly I doubt it will until those writing the regulations grasp the point that, for many, drawdown is not a product purchased as a transaction. Instead, it is an option, or even a service, which sits inside a pension.

An architect building a multi-storey property in place of a bungalow wouldn’t work with the same foundations. They’d dig them out and start again.

Unfortunately, I’ve seen limited evidence of similar intent in the retirement world.

Gareth James is head of technical resources at AJ Bell