The rationale behind the FCA’s investment pathways solution is sensible but, believes Steven Levin, the initiative does need tweaks – particularly since it risks exacerbating the real issue: a lack of engagement
Being ‘your own worst enemy’ may be a cliché but, as with most clichés, it has an element of truth to it – and it neatly sums up the challenge around engagement with pensions.
The consequences of the introduction of pension freedom continue to reverberate from all corners leaving providers, the regulator and the government scratching their heads about how best to help the public navigate this uncharted water.
One of the biggest worries is unadvised drawdown. An outsider looking in at the savings policy landscape would likely be baffled by a system that handholds the public all the way to arguably the riskiest point – when they start withdrawing from their pension and need the money to last – only then to let them wander off alone.
The Financial Conduct Authority (FCA) looked at this issue and came up with a logical solution – investment pathways for the four most common scenarios.
While the rationale is sensible, however, it needs some tweaks, particularly since pathways risk exacerbating the real issue – a lack of engagement. What we do not want is regulation that gives people misplaced confidence to make a single decision on an investment pathway and think their retirement funds are sorted.
While decumulation should not be the ‘sink or swim’ situation it has been in the past, implementing pathways is akin to giving people a floatation device rather than teaching them to kick their legs or putting them on a boat. Investment pathways will not increase engagement of customers – if anything, they may reduce it. Consumers will think a passive generic investment solution with a relatively low price cap is the ideal option and so may see no advantage in using a financial adviser or further thinking about their retirement funding plans.
In fact, given the FCA has suggested the investment pathways should be built with reference to five year objective timeframes, consumers will likely end up in a low-risk portfolio, even if they are comfortable investing a higher proportion of their fund into higher-risk investments.
Most portfolio managers will agree five years is not a realistic time-frame for any investment strategy with high risk content and so the likelihood is that most investment pathways will be heavily biased towards protecting the downside risk – perhaps using a mix of cash, gilts, bonds and other fixed interest investments.
A relatively straightforward fix for this would be to extend the timeframe – however, there are many other scenarios where tinkering with investment pathways will not stop consumers missing out on the added value of advice on an ongoing basis and the outcomes it generates.
An adviser would, for example, make sure pension fund withdrawals are made in the most tax-efficient way and only at a time when they are needed, which can result in someone’s retirement pot lasting for a lot longer. Without this guidance, clients in a pathway might opt for big one-off withdrawals that incur high levels of marginal rate income tax and then end up sitting in a low interest-bearing savings account.
With the right financial planning, the vast majority of pension fund withdrawals – if not all – can be tax-free for anyone with a regular income need in retirement of up to £18,300 a year. That is often a saving of several thousands of pounds.
While these criticisms are problematic, they are not game-changing and do not undo the potential good of investment pathways. There are, however, some further safeguards that should be put in place to reduce the risk.
For those who do not have an adviser, we would recommend the implementation of mandatory guidance provided by the Money and Pension Service (MAPS), which could be implemented through a triage system. Investment pathways already have a point in the process where providers are required to check whether the customer has accessed MAPS.
If they have not, then unless they have received financial advice, or their savings are below a certain threshold, or other extenuating circumstances, they should be required to obtain guidance. This would provide a final safeguard to check whether their circumstances require more detailed planning.
In fact, experience shows a large proportion of those who have accessed guidance do go on to seek financial advice. Figures from Pension Wise, for example, show that 49% of those who had an appointment went on to speak to a financial adviser, tax adviser or accountant.
Nevertheless, with more than half a million pots being accessed each year and a vast remit of responsibilities, the government and the regulator need carefully to consider the resources available to this body. Ultimately, ensuring the public pay more attention to, and engage with, their pensions must remain the longer-term goal.
Steven Levin is chief executive officer of Quilter’s UK platform, Old Mutual Wealth