Jeremy Martin: With choice comes responsibility

Consumers have enjoyed five years of pension freedom but with choice comes responsibility, writes Jeremy Martin. Here he discusses the introduction of investment pathways...

It’s been five years since the introduction of pensions freedom, and for many, it’s been a phenomenal success.

It’s allowed numerous pension plan holders to exercise the power of choice as to how they access their pensions and optimise their decumulation strategies in the most appropriate manner to suit their own circumstances.

However, with choice comes responsibility. Converting pension capital to pension income is a complex decision with many variables to consider, such as levels of income to take, impact of inflation, investment performance, sustainability over the long term i.e. 30 or 40 years and many more. All of these require consideration against the needs of the consumer.

The regulator has become increasingly concerned that many of those who have exercised their rights to access their pension pots have perhaps not quite realised the complexities and long-term implications of what they have done. Particularly when they have accessed their pensions without the benefit of regulated financial advice.

The final Retirement Outcome Review (ROR) and subsequent Policy Statement (PS19/21) (post-consultation) is designed to offer a series of ’remedies’ to help counter some of these issues. The final rules in the words of the FCA are as follows:

  • Introducing ‘investment pathways’ for consumers entering drawdown without taking advice
  • Ensuring that consumers entering drawdown invest predominantly in cash only if they take an active decision to do so
  • Giving consumers in decumulation annual information on all the costs and charges they have paid

According to the FCA (PS19/21), among the list of those affected by this are:

  • Individuals and firms providing advice and information in this area
  • Distributors of pension and retirement income products
  • Consumers of pension and retirement income products

The overarching aim is to:

  • Improve consumer decision-making
  • Promote competition by making the charges associates with drawdown products clearer and comparisons easier

ROR found many areas of concern, such as consumers only being focused on taking their tax-free cash. Perhaps taking the path of least resistance by not looking beyond their existing provider. Charges on products varying from 0.4% to 1.6%.

Furthermore, there were some providers defaulting consumers into cash or cash-like assets, thus consumers were potentially missing out on the opportunities for investment growth – potentially having a reduced income of 37% in comparison over 20 years as a result.

In a nutshell, the problems highlighted above can be encapsulated as follows:

  • Non-advised drawdown consumers were unsure where their funds were invested
  • The investments didn’t often align with their retirement objectives
  • Many were invested in cash without it being an active decision
  • Consumers might have been defaulted into cash as part of a move to drawdown – and were perhaps still in cash

Originally this second set of pathways was due to come into force on 1 August 2020, but due to the impact of Covid-19 the FCA pushed this back by six months to 1 February 2021.

And I quote: “This extended implementation period recognises the operational challenges of implementing new rules in the current circumstances.”

The pathways

The result of all this is as follows:

In essence, where a non-advised consumer wishes to move their pensions from a savings environment into drawdown, or if they wish to transfer funds that are already in drawdown, providers must offer the following investment pathways as objectives, alongside the other investment options they may offer:

  • Option 1: I have no plans to touch my money in the next 5 years
  • Option 2: I plan to use my money to set up a guaranteed income (annuity) within the next 5 years
  • Option 3: I plan to start taking my money as a long-term income within the next 5 years
  • Option 4: I plan to take out all my money within the next 5 years

Providers must offer each client a single investment solution which relates to the pathway they have chosen.

As well as a yearly statement, where a consumer has been in the same pathway for 5 years the provider must send out a reminder detailing the number of years they have been invested in this pathway. There are also requirements about communications and record keeping where significant amounts of cash are being held i.e. 50% or more.

Points to consider

The definition of a non-advised consumer – Advised consumer is treated as non-advised if more than 12 months after the transaction they were advised on; or within 12 months and have not confirmed circumstances are unchanged since advice was received. The fact the provider is facilitating an ongoing fee to an adviser isn’t relevant within this – so that fee could be being paid but the client could be deemed non-advised for the purposes of investment pathways

UFPLS and fixed-term annuities are exempt.

Consumers phasing into retirement only need to go through the pathways process once, if it’s pre-planned.

Record keeping

As ever, record keeping by providers is essential e.g. how many advised and non-advised consumers entered drawdown; numbers who chose (or not) an option and investment pathway fund and so on.

The rules are highly prescriptive, and the provider must ‘follow’ the client through the process to record what decisions they make – be it online, phone or paper-based. The question arises as to what the FCA is going to do with this information?

There is an exemption available to providers if they (the firm) are satisfied that there are fewer than 500 non-advised consumers who will move into drawdown. It must have reference to the number who have designated in the last 12 months and the firm’s business plan.

If a firm is exempt, they don’t have to design and build pathway investment funds, but need to communicate with clients about pathways, ensure record-keeping and refer consumers to the Money and Pensions Service (MaPS).

Looking to the future

The deadline for the completion of these changes is now 1st February 2021. It’s the ambition of the regulator that the investment pathways and cash warnings are enough to achieve their aims and thereby benefit the consumer by providing more clarity around a complex subject.

Finally, what does this mean for advisers? It’s often the case that what the regulator considers appropriate in one area of pension planning often finds its way into others.

In this case, could a focus on investment options and value for money together with alternatives at possibly lesser costs drive down the cost of advice? 

The levels of product or fund governance might serve as a benchmark for how deeply advisers will have to go when considering fund choices within their centralised retirement processes. As usual, only time will tell. 

Jeremy Martin is pensions, tax and estate planning consultant at Canada Life