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How the FCA’s pension freedoms review could reshape retirement

Tom Selby, senior analyst, AJ Bell warns the industry must use the consultation period to flag both the practicalities and any potential unintended consequences of the FCA’s proposals in its Retirement Outcomes Review

Former Chancellor George Osborne’s shock pension freedoms announcement in the March 2014 Budget caught everyone on the hop – the Financial Conduct Authority (FCA) included.

Along with the pensions industry and HMRC, the regulator was forced to scramble its resources ahead of the April 2015 launch date.

The revolutionary nature of the changes, coupled with the short timescale for response, left the FCA in an almost impossible position. How do you build a suitable regulatory framework when you have no idea what savers will do with their new found freedom choice?

It has taken the FCA more than four years to assess the retirement income market, analyse the behavioural response of savers and posit interventions to help non-advised investors in particular navigate their way through drawdown.

The recently published Retirement Outcomes Review sets out the regulator’s first serious reflection on the pension freedoms market.

Positives

There are many things in the report to be positive about. It acknowledges that many savers have welcomed the freedoms and the new flexibilities offered to savers.

Furthermore, the regulator has not found evidence of savers irresponsibly splurging their hard-earned retirement pots too quickly – although it will understandably keep a close eye on this and continue analysing the available data.

However, lack of engagement in drawdown was identified by the FCA as an area of potential concern.

Around one in three consumers who have gone into drawdown recently are unaware of where their money was invested, the FCA said, while others “only had a broad idea”.

Furthermore, there is some evidence people could be making less-than-perfect investment decisions, with a third of non-advised customers just holding cash.

For many this will be an active choice. Some will fear a stock market downturn is on the horizon, for example, while others could be planning to take large withdrawals from their pot. It could also capture new investors who are simply yet to pick the funds they want to buy.

However, investing solely in cash is clearly a poor long-term plan for most people, particularly with inflation now eating away at your capital. According to the FCA, someone who wants to drawdown their pot over a 20 year period could increase their expected annual income by 37% by investing in a mix of assets rather than just cash.

Interventions

The FCA has taken a two-pronged approach to remedying these perceived market failures.

The first prong focuses on improving the way people receive retirement information from their provider. The regulator wants firms to send retirement wake-up packs from age 50 – five years earlier than under the current requirements – and then every five years from then onwards.

Firms will also be required to provide retirement risk warnings alongside wake-up packs, and the regulator is also wants savers to be given a one-year charges figure prior to entering drawdown.

The FCA’s proposed overhaul of the information providers send to customers is welcome and long overdue. Indeed, we believe much of the literature issued to customers is barely read and poorly understood, and have long called for a fundamental rethink in this area.

Our own research points to a lack of engagement and understanding among many drawdown investors, with accessing tax-free cash often the priority.

In this context, decoupling accessing tax-free cash from taking a decumulation decision – a policy supported by the FCA but which requires legislative change – would be a step in the right direction.

From the perspective of a saver it seems bizarre that you can only access your tax-free lump sum after making a retirement income decision – particularly if you have no particular plans to actually take an income.

The second prong looks to build on these communications nudges with a series of market interventions.

Savers could be required to make an active decision to invest in cash – a move designed to ensure people don’t miss out on valuable investment returns – while a new disclosure regime proposes information on the charges customers actually pay is disclosed on a yearly basis.

Perhaps most controversially, the FCA wants providers to offer ‘investment pathways’ for customers who might otherwise not engage and end up investing in a way which doesn’t fit their long-term plans.

If the regulator does press ahead with this proposal – and it should be noted this is just a consultation at this stage – it will need to carefully consider both the practicalities and any potential unintended consequences.

Ultimately successful navigation of drawdown requires engagement and care needs to be taken that creating blanket pathways doesn’t simply hard-wire inertia into the system.

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