Pensions freedom, while giving welcome increased flexibility for consumers to access their savings and offering greater opportunity for advisers to engage and offer advice, are likely to create many challenges of which advisers should take note.
According to HM Treasury, 320,000 people each year retire with a defined contribution (DC) pension.
However, this is expected to be higher as those who deferred buying an annuity after the 2014 Budget seek guidance. The guidance is expected to cover topics such as life expectancy; the various pension products available; long-term care; and the calculation of tax, but the precise detail is still to be confirmed.
In launching its Pension Wise brand for guaranteed guidance, HM Treasury will make clear the value of paid-for regulated advice, where consumers need more information or a specific recommendation on how to proceed.
Whether or not consumers follow this up or simply access the internet or their existing pension company, remains to be seen.
Factoring in emotion
Behavioural factors may present issues that affect retirement income decision-making, and the ability of consumers to achieve ‘best value’.
• inertia and procrastination as taking an income will require an active decision and complex choices;
• a poor grasp of life expectancy;
• the breadth of choice relating to the retirement options available;
• a lack of trust in the pensions industry;
• fear of the unknown and of losing control of their funds;
• regret and loss aversion;
• hyperbolic discounting, that is placing more value on today over tomorrow and next week;
• the effect of ‘framing’ in the presentation of information; and
• mental accounting, where people tend to place funds in different pots for different purposes and are likely to overspend lump sums which are viewed as available for immediate consumption, which may result in a predisposition against depleting capital.
Much has been written in the press regarding an expected increased demand from clients for flexi-access drawdown post-6 April 2015, or the desire to withdraw all of their funds at once, to spend, or more likely re-invest in other investment vehicles.
• transferring funds into cash accounts such as a cash ISA,
• purchasing buy-to-let property,
• collective investments such as ICVCs, unit trusts and investment bonds, as well as,
• annuities, whether in their existing form or new versions under development for the future.
All of these options carry risk to the long-term value of the fund or investment which may not be appreciated by the client, if they do not receive advice.
Clearly repaying unsecured debt with a cash lump sum is likely to be good practice, however, advisers should be cognisant of the rates of interest for various loans and the benefits or not of withdrawing funds, over and above those that are available tax-free, that will necessarily attract a tax charge at the client’s highest marginal rate.
Grasp the concept
Recent research by the International Longevity Centre UK (ILC-UK) shows clear evidence that consumers do not have a clear understanding of the concept of marginal rate taxation.
Pension flexibility also raises questions about how lenders will treat an uncrystallised pension pot when negotiating debt or mortgage repayment with borrowers, and their attitude to older borrowers should they fall into arrears.
The Financial Ombudsman Service (FOS), in its 2015-2016 plan and budget, published earlier this month, is asking the industry for their views on whether there will be an increase in complaints as a result of the new pension freedoms.
Where you make a recommendation, and the client chooses to take a different course of action, perhaps to draw a larger income than you assess to be prudent or to withdraw a larger proportion or their entire fund as cash, you should think carefully about processing this type of business.
It is anticipated that although the initial wish may be to take full advantage of the pension freedoms, a large proportion of clients will want the surety of a secure income, with or without an element of guarantee, and so the cry that annuities are dead, may be premature.
In conversations with providers, it’s clear that they are not inclined to deal directly with clients in accessing their funds, and will only wish to enter into drawdown arrangements via an adviser, who has provided advice and taken responsibility for the initiative.
It is likely that there will be the requirement to pay greater attention to cash-flow modelling, particularly to illustrate the effect of decisions on longer term income in the context of increased longevity and well documented evidence that clients underestimate their life expectancy.
Ultimately it must be remembered that the legislation allows clients to withdraw all of their funds, once they reach age 55, should they wish.
It is our role as advisers to discuss and document all the options and to ensure that our recommendations are suitable and are made in the best interests of the client.
Aileen Lynch is head of technical at Compliance First