It’s eight years this April since pension freedoms were introduced in the UK. It’s probably still too early to say they were a complete success, but at least we have some data to show what people did with the new rules.
Some of the tax-free lump sums have already made their way into the real economy via cruises, cars and house extensions. But from the get-go the big phenomenon was "drawdown", which provides an income from a pot that remains invested in (and exposed to) the stock market.
The key question for regulators is whether people who sought and seek help about retirement income received suitable advice from the professionals they paid to deliver it.
To this end, the Financial Conduct Authority (FCA) has launched a "thematic review" into retirement income advice, during which it will collect information from advice firms.
Such reviews look at ongoing issues and identify problems and risks before more detailed investigations take place. The FCA calls this "discovery work". But the work also has a link to the Consumer Duty rules, which will kick in this July.
By reviewing a selection of advice firms for this income advice review, the regulator will be able to assess how well the industry is gearing up for the broader changes too. It’s already flagged up that some firms are behind in their planning, so it may not be plain sailing.
State Pension Looms Large
We can’t pre-judge the outcome of this thematic review – the regulator may find that, on the whole, this section of the market is performing well – but it’s worth adding some context.
Currently the national conversation is about increasing the state pension age, a decision the government is expected to announce in the next few months (the media is already speculating this is a done deal).
That's really important because of the cost of living crisis, which is stretching retirement incomes and possibly deterring some potential retirees from taking the plunge. Meanwhile, some 50- and 60-somethings are being encouraged back into the workforce anyway, and early data suggests that is genuinely happening.
For its part, the state pension is about to increase by 10% this year as part of the "triple lock", a much-debated policy designed to increase payments by the higher of inflation, wages, or 2.5%. For people relying on their state pension as the bedrock of their retirement, that really matters. But there are other things to consider.
Annuity rates, bond yields and cash interest rates – previously staples of retirement income – have risen sharply in the last year. And to throw more confusion into the mix, the once- sleepy defined benefit market was thrown into turmoil last year when the mini-Budget spooked the markets. Life expectancy increases, meanwhile, are a pain for actuaries but a boon for those living longer. They appear to have plateau-d. No wonder people seek financial advice to navigate these minefields.
In this environment, the pension freedoms are supposed to allow people more choice over their defined contribution pension pots. In 2015, many people took advantage of the policy straight away without asking for financial advice. Rather than buying an annuity and living off the income, we got six new "mix-and-match" options:
1. Leaving the pension pot untouched;
2. Purchasing an annuity;
3. Getting an adjustable income (flexible-access drawdown);
4. Taking cash in chunks (uncrystallised funds pension lump sum);
5. Cashing in the whole pot in one go;
6. Taking 25% of the pot tax-free.
Working Harder
Politicians were the instigators of these freedoms – but from the moment they were announced there were worries about how much help and support savers would get.
"The pension freedoms gave people the freedom to choose what to do with their money. These new freedoms also brought new risks. On balance, these changes have been a success and we do not want to see them rolled back," MPs said in a report by the cross-party Work and Pensions Select Committee in 2022.
"However, many savers need more support than they currently receive in order to make good decisions about how they access their pension savings. We recommend that the government and regulators should play a more active role in supporting savers than they did when the pension freedoms were first introduced." (My italics).
This leaves the FCA in a tricky position. Political and popular support for the freedoms remains strong, which means its role can only be to look at drawdown products and how advisers recommend it, rather than assessing whether the freedoms work in general.
How is this likely to pan out? Advice firms are not likely to take this scrutiny lightly. As the British Steel saga showed, many advisers gave unsuitable advice to switch from defined benefit to defined contribution schemes. The regulator has been at pains to point out that, in most cases, pensioners would have been better off staying put. Advice firms can ill afford another bout of bad press.
As flexi-access drawdown involves investing a pension pot into a market or funds fund to get income, market risk is a strong part of this equation. Annuities were simpler to understand, weren't linked to stock market performance, and offered predictable income.
As the Department for Work and Pensions said in its 2020 report: "income drawdown providers offer a range of different investment funds, with different investment objectives, risks, and levels of charges." That is a minefield for consumers.
Such products are mostly "off the shelf" strategies designed by providers and fund houses but, despite the FCA's best efforts to establish "pathways" for providers to design their products around, there isn't really a one-size-fits-all solution.
Looking For Evidence
The FCA knows that the cheapest products aren't always the best for clients, but it will want to see evidence that the products that advisers recommend are appropriate to clients' individual circumstances, and will be looking for real-life examples through case studies. Most financial decisions are not irrevocable, so a product that might be suitable in your 50s may not be appropriate in your 70s. A good adviser will account for this.
Regulators will be keen to see firms complying with the rules – especially with the Consumer Duty looming – but part of that will involve seeing how firms arrive at their recommendations. This was a big part of the British Steel fallout, as even reputable advice firms were found wanting in the way they documented their own processes.
"Advice in this area can be complex, so it is important firms understand the needs of their consumers and ensure their advisory solutions deliver consistently suitable advice," the FCA said last week, announcing the review. If you're a client of an advice firm, you can ask your adviser about this. Your adviser should be happy to reassure you.
What Happens Next?
The FCA is collecting information from firms this year and will publish a report later in 2023. It had already made a start on this but was derailed by the pandemic, so delays in publication are possible. The Consumer Duty rules are likely to kick in first, and they’re due in July. We'll also likely get a decision on the state pension age before then. Having to retire later will put a further premium on good advice and good products.
Generation X, a now forgotten demographic of people born between 1965 and 1980 without Baby Boomer privileges or Gen Z cool, are the guinea pigs of this deferred retirement era.
By the time they eventually step back from the workforce, final salary pension schemes will be rare indeed, and the triple lock could well be gone. Retirement income will have to be handled very carefully indeed. In that sense the FCA’s work will be as much about the past as about the future. The next 10 to 15 years could be crucial.
