Three years on from the introduction of pension freedoms, how is the retirement income sector serving consumers?
The Financial Conduct Authority (FCA) has launched a new consultation designed to protect consumers, improve engagement and promote competition in the retirement income market.
This consultation has been published alongside their final report, part of the FCA’s Retirement Outcomes Review, which is a detailed look at how the sector has been working for consumers since the introduction of pension freedoms in April 2015.
The headline findings of the report show that these pension freedoms were welcomed by consumers, but some are at risk of financial harm. It’s this risk of consumer detriment the consultation is seeking to address.
This review is especially important because the amount of money in defined contribution pension pots is expected to rise significantly in the coming years.
With retirees increasingly likely to have pension wealth held within defined contribution rather than defined benefit (final salary) pension schemes, it’s important the retirement income sector serves them better.
One interesting finding in the report, which is something we don’t often expect to hear from the financial services regulator, is that some investors using income drawdown in retirement could receive 37% more retirement income each year if they invested their pension pots in a mix of investment assets, rather than holding the money in cash.
The FCA reported that 60% of consumers who do not take advice about their income drawdown for retirement income were not sure or only had a broad idea of where their money was invested.
They found that a third of consumers were wholly invested in cash, with around half of these people likely to be losing out on income in retirement, due to their cash strategy.
Cash is a good short-term home for money, but retirement can be a very long-term investment. Over longer periods of time, the buying power of cash is typically eroded by price inflation, with invested assets standing a better chance of delivering inflation-beating returns.
Within the consultation, the FCA is aiming to help consumers at key stages of their retirement income journey. It also looks to provide better support to investors once they have accessed their pension pot, especially if that access is a flexible format such as income drawdown.
The FCA wants to improve the clarity and timings of communications before people make decisions about what to do with their pension pot. It also looks at simplifying the options people face and the ongoing communications they receive.
One proposal is for ‘wake up’ packs to be sent to pension pot owners on their 50th birthday and then every five years until the pension pot has been fully accessed.
These new style information packs will need to include a single page summary, sometimes referred to as a ‘pensions passport’. Pension providers will need to include specific retirement risk warnings within the packs too.
According to the FCA, this new communications regime will be designed to address the lack of consumer engagement, helping consumers better engage with the risks and choices they face, prompting them to access the support and guidance needed to make better choices when it comes to retirement income.
Another proposal within the consultation is to create so-called ‘investment pathways’ for investors who are entering drawdown. These would consist of a more structured set of investment options, designed to help investors engage with the decisions they are making.
Investment pathways would also aim to consider their retirement objectives and ultimately end up in a more appropriate investment solution.
For investors who enter income drawdown arrangements without the benefit of professional advice, the availability of a set of investment pathways could go some ways towards better investing outcomes.
Value for money was an important part of the report, with the FCA proposing firms include a one-year charge figure, shown in pounds and pence. This price disclosure would be made in a key features illustration.
The report shows a big variation in charges between different retirement income plans. These charges can range from 0.4% to 1.6% a year, and comparing them isn’t always that simple, with complex and opaque charging structures from some pension providers.
The FCA has warned that failing to introduce investment pathways with appropriate charge levels could result in a cap on drawdown charges. However, this charge cap is not being proposed within this consultation.
Christopher Woolard, Executive Director of Strategy and Competition at the FCA said:
We know that the choices introduced by the pension freedoms have been popular with many consumers. However, they’re now required to make more complicated decisions than ever before. Many people need more support when making choices.
The measures we have outlined today will help them think about that earlier, create investment pathways to help them with their choices and make costs and charges easier to understand.
This is an important market that is still relatively new and is continuing to evolve. This is not the end of the work we are doing and we will continue to keep the market under review as it develops.
It will be interesting to see what happens next and how the retirement income market continues to evolve.
Some of the proposals made by the FCA in their consultation are being consulted on as proposed new rules. Other regulatory interventions, including the investment pathways approach, will be subject to further work to consider the detail of implementation.
Commenting on the report, Steve Webb, Director of Policy at Royal London said:
This is a welcome package of measures from the FCA. The report shows that consumers who do not take financial advice are at risk of losing out, with 94% not shopping around at retirement.
The biggest risk is not consumers running down their pension pot too quickly – for which the FCA says ‘it has not seen much evidence’ – but savers locking their money into low-return cash investments for decades. Making sure savers do not sleepwalk into cash investments is an important step, as well as simplifying choices for savers at retirement.”
These recommendations are a proportionate and balanced package which preserve the spirit of pension freedoms whilst trying to make those freedoms work better, especially for customers who do not take financial advice.
If you have any questions about your retirement income options, please do get in touch and we will be happy to answer them for you.
