As a result of its retirement outcomes review, the Financial Conduct Authority (FCA) is consulting on whether an unadvised individual who moves into income drawdown should, unless they make other choices, be placed in a default drawdown pathway. The proposal includes four default drawdown pathways designed for an individual who:
- Does not plan to touch their money in the next five years;
- Plans to use their money to buy an annuity in the next five years;
- Plans to draw down their money to provide long-term income in the next five years; or
- Plans to withdraw all their money in the next five years.
A provider does not have to offer more than two of the defaults. It will be required, however, to signpost other providers that offer defaults it does not.
Around 90% of pension savers are in default accumulation funds. Why? Because it is easier to go with the flow rather than engage with their finances and make a choice. The consequences of this behaviour when accumulating wealth are not catastrophic – default accumulation funds can therefore be justified.
The fact that the FCA recognise that four defaults are required for a five-year timeframe shows it has identified that one default retirement fund for those who have begun to access their pension savings could never be appropriate to all.
It is very difficult for an individual to visualise what their life will be like in five years. Many events are not in the control of the individual. Redundancy, ill health, change in family circumstances all occur without warning. The older you get, the frequency at which they occur seems to increase. Therefore, if a correct default pathway is selected when they first access their pension savings, it could soon be the wrong default.
A concern is how it is intended to transition from the accumulation default fund into the ‘appropriate’ default pathway. If the default pathway is to occur from the date 25% tax-free cash has been drawn, significant damage could have been done if that 25% is withdrawn at the wrong time from the wrong investments. Therefore, the default pathway should be selected in advance of such action.
For those pathways that involve withdrawing money, the investment mix would need to be different depending upon how much they intend to withdraw and when the withdrawals will take place. Is it to be within six months or towards the end of the five-year period? If income withdrawals are to apply, the amount of income withdrawals can affect the investment decision.
Quality advice is essential to successful retirement outcomes. However, the existence of default pathways is likely to lead to less people seeking advice. Why pay for ‘costly’ advice when the professionals at the pension provider have simplified it all for me into four pathways at no cost? If they only provide two pathways, I can shoehorn myself into one of them rather than face the hassle of moving to another provider.
Savers often have more than one pension. It is anticipated that on average the typical auto-enrolment pension saver will have 11 pensions by the time they retire. Should they consolidate them? Should they draw them in sequence? What is the most tax-efficient way of using them? How do they assess what income they can afford to draw as against what income they need?
They need guidance to help them decide their course of action before they even get to a pathway. Should they even be touching their pension at this time? They may have other assets that are not so tax-efficient as a pension but are tax-free on withdrawal. Should they be looking to draw down those assets before they even look at drawing their pension?
Recent research published by OneFamily, an equity release provider, shows over-65s hold five times more wealth in their homes than they hold in their pensions. The same research indicates 19% of over-50s say they will use some of that equity to make up for the shortfall in their pensions.
The question then arises – when and how will they access their housing wealth? The answers should affect decisions made about their pensions. For example, they may decide to target the use of equity release when they reach age 85 to finance their final years. This could mean that they are looking for their pension to provide them with income until that age. Not a lifetime income. This will require a different investment and withdrawal strategy than someone who is looking for a lifetime income.
On the other hand, they may decide that within the next three years they will downsize and realise a significant cash sum. Their needs are income from their pension until that materialises, live off the proceeds of the downsizing until it expires and then return to drawing their pension. This requires a completely different investment strategy to any of the pathways.
Just starting with what appears to be an easy pension decision quickly illustrates that there are no one-size fits all retirement financial planning decisions. If the FCA really wants to improve financial outcomes for those moving into retirement and beyond they should be concentrating upon how they get more to receive holistic guidance and advice, rather than promoting default pathways that will be taken up by the many, but in practice will be appropriate only to the few.
Bob Champion is chairman of the Later Life Academy