How to Make the Right Retirement Choices

Could the Financial Conduct Authority's Investment Pathways scheme help you to make a roadmap for retirement? 

Faith Glasgow 10 May, 2021 | 9:48AM
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If you’re approaching retirement and wondering how best to convert your pension pot into a sustainable regular income once you stop work, you’ll be glad to hear that help is at hand, in the shape of the Financial Conduct Authority’s new Investment Pathways (IP) scheme.

Growing numbers of savers in the UK have a defined contribution pension worth tens or even hundreds of thousands of pounds, but often little idea what they should do with the money. Worryingly, a common response among those without a financial adviser to guide them has been one of excessive caution i.e. stashing their pension cash in the bank.

Don't Leave Your Savings in Cash

A report by the FCA in 2018 report found that since 2015, when the pension rules changed, a third of people who had withdrawn their pension savings and did not take professional advice were holding the whole lot as cash savings, either because they didn’t trust the stock market or because they didn’t know where else to put it.

That’s fine as a short-term arrangement – but over the decades not only is the money likely to lose real value as it earns below-inflation interest in a savings account, but it is also no longer protected from the taxman’s beady eye.

The Investment Pathway scheme has been designed to make it easy for people to find a more appropriate home for their taxable pension at retirement, by providing four simple choices once the 25% tax-free lump sum has been taken.

It is available from insurers including Standard Life and Prudential, from Sipp providers such as Fidelity, Hargreaves Lansdown and AJ Bell, and from other pension providers including PensionBee.

(It’s worth pointing out that so far, the scheme has not been rolled out right across the UK pension arena, but only by those providers regulated by the FCA. Other employers use a different pension arrangement called a Master Trust regulated by the Pension Regulator, but it is expected to bring in something similar in due course.)

How do Investment Pathways Work?

The first step is to choose a provider (more of which later). You’ll then need to choose which of the four Investment Pathway scenarios most accurately reflects your circumstances. For each IP the provider will offer an appropriate low-cost (generally passive) investment recommendation. You can either put your money straight into it, or use the fund’s composition as a guide in researching a suitable alternative.

Option 1: I have no plans to touch my money in the next five years

You may choose this option if you have other pensions or income sources to live off for the moment, and can afford to leave the money at least partially invested in the stock market where it is likely to grow over the longer term.

However, different providers offer quite different funds, ranging from PensionBee’s equity-based fund, through a balanced fund from interactive investor, to Hargreaves’ bond-dominated choice. It’s therefore important to be clear just what you’re investing in.

Option 2: I plan to set up a guaranteed income plan (annuity) within five years

If you’re planning to buy an annuity, the key is to ensure your money keeps pace with any fluctuations in annuity rates.

Annuities invest in long-dated government and corporate bonds, and so annuity rates move in line with bond yields. Ideally, then, your pension pot will be invested in a fund of bond holdings of a comparable duration that will be similarly affected by changes in interest rates.

While few pension investors in their 60s are drawn to annuities, given the poor rates now available, they become increasingly attractive as people get older and seek greater income security. Not only do rates improve with age, but you may qualify for an "enhanced annuity" with better rates still if your health deteriorates. There is nothing to stop you reviewing your IP choice again at a later date if you do want to buy an annuity in years to come.

Option 3: I plan to start taking a long-term income within five years

This pathway is about income drawdown; it’s designed for the growing number of people who want to leave their pension invested but start taking regular or occasional withdrawals in the next five years.

The big danger is that the fund is invested too conservatively and doesn’t grow enough to see you through the next three or even four decades. Most providers therefore use a balanced fund holding equities plus less volatile assets, though again there are significant differences between the different offerings.

Option 4: I plan to take all my money out within five years

If you plan to cash in your pension pot altogether in the next few years, option 4 is the best choice. The focus is on protecting the capital value of the pension, rather than income sustainability or growth.

That rules out stock market investments, which are too volatile for such a short timescale. Instead, funds selected for option 4 make use of bonds, money market and cash holdings, aiming if possible to preserve the real value of the investment. But there is a risk that pensions invested in these choices will nonetheless become worth less over time, as charges and inflation outpace returns.

How to Choose a Provider

You could stick with the Investment Pathways offered by your current pension provider but as we’ve seen, providers have taken significantly different approaches in their choice of pathway fund, and it really does make sense to look across the wider market to find the best option for your circumstances. 

A good place to get an overview is using the Investment Pathway selection tool provided by the government’s Money Advice Service. It’s not comprehensive, but it does have details of the fund being used for each pathway by some of the main providers, and also allows comparison of the cost of that pathway in the first year, which can again vary considerably across the market.

You may be quite comfortable picking and managing a portfolio of funds to suit your financial retirement plans. But if you don’t have an adviser and would rather someone else did the heavy lifting with a ready-made solution, the Investment Pathways are a useful resource that should keep your money on track.

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Faith Glasgow  Faith Glasgow is a freelance journalist specialising in pensions and investment trusts