Pension freedoms bring greater risks as well as choice, especially for those who don't take advice or guidance. But, Andrew Tully argues, the FCA and providers can help…
The 2014 Budget is now a distant memory, but the aftershocks and tremors of the monumental pension changes instigated that day continue to be felt.
Overall, it is hard to argue with the fantastic freedom and choice being introduced. And it is obvious this has huge appeal. But with such unfettered choice comes the potential for poor customer outcomes.
That's where good advice, and hopefully the new guidance guarantee service, will help people use this new freedom in a way which suits their individual circumstances. But what about the 50% and more who won't access guidance or advice – what defence is in place to help them?
Before I go any further, I should say I largely support these changes. Giving people more control over their savings is a positive step. The new liberalisation will, with the right advice and guidance, improve outcomes for many thousands of retirees. However, there is a "but".
Those who don't get any advice or guidance run many risks, any one of which could have a major impact on their financial well being.
In the industry, many of these risks are well known. Withdraw too much too quickly from your pension after April and you may pay higher rate income tax, or even the 45% level. But with some basic planning, the tax implications can be significantly reduced.
And once withdrawn, what will people do with that cash? Some will use it to pay off debt, or enjoy life and those may well be realistic objectives.
Other research suggests some will simply store in a bank account, and with very low interest rates they will soon be eating into capital.
For those who want to retain funds within a pension and gradually draw an income, there are other risks. More than eight in ten people underestimate their life expectancy – significantly so in many cases. So even with careful management of funds, many of these people may run out of money.
And the sequence of returns risk, which means poor returns coupled with large withdrawals in the early years of retirement, can have catastrophic impacts on the long-term financial health of pension funds.
Advice – and to a lesser degree, guidance – can help raise awareness of these issues, and help people make informed decisions. But those who get neither will be dependent on friends, internet, media and the information they get from the holding provider.
When trying to work out if that will be sufficient, we can refer back to the open market option – a relatively simple message to encourage people to shop around for the best deal.
Yet it failed, with about half of people sticking with holding providers and the Financial Conduct Authority (FCA) itself revealing more than 80% of these lost out on a better deal.
And the choices in the new world after April 2015 involve much more complex messages than just the need to shop around. So we should not kid ourselves that this is easy and everyone can automatically get an ideal solution.
That's where the FCA should come in. We need to introduce regulation forcing all providers to have a second line of defence. For example, introduce a requirement to talk and listen to customers who have not taken advice or guidance, and help these people from inadvertently making poor choices.
Providers will have a duty to signpost towards guidance, and to provide relevant information to customers, such as describing the tax implications of different options.
But if a customer chooses not to take up guidance or advice, we need a fallback to minimise the number who end up being sold solutions that do not meet their needs or pay out significantly less than the competitive deals available in the market.
People have been given the chance to make the most of their hard-earned savings and trusted to take accountability for their own financial futures.
Providers have a responsibility to help people make the right decisions by talking to them in engaging and simple ways, and by developing compelling products that people want to buy.
But the regulator also needs to protect customers who are not getting access to advice or guidance. A second line of defence is in all of our interests, so we can avoid repeating the mistakes of the past.
Andrew Tully is pensions technical director at MGM Advantage
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