Can Investment Pathways help avert a retirement income crisis?

We analyse the latest FCA data on accessing pension pots and consider how Investment Pathways, going live in February, could help avoid a future crisis in retirement income for non-advised customers.

It’s been five years since Pension Freedoms gave customers more flexibility in the way they access their pension pot in retirement. But how successful has it been? As expected, there have been many benefits; customers have not had to lock into historically low annuity rates, they have had more choice on how they invest their money, and they have enjoyed the flexibility to take money as they need it. The latest FCA data, published in September 2020, suggests that consumers have made the most of Pension Freedoms. In the 12 months leading up to April 2020 only 10% of those accessing pension pots for the first time chose to take an annuity, while over 55% of them took a full cash withdrawal from their pots. But the advent of Pension Freedoms has not been without drawbacks. The latest data highlights some important challenges.

The growing advice gap

We know there is a big advice gap in the UK, but the latest data shows it is growing, especially when it comes to accessing drawdown products. The data suggests 27% of those entering drawdown are not accessing regulated advice or seeking guidance from Pension Wise.

Perhaps unsurprisingly the advice gap is even bigger for smaller pension pots. For pots under £100k, around 32% are not accessing advice or guidance from Pensions Wise. This is up from 29% in the previous year.

Some of the reasons behind the figures may be that smaller pots do not warrant the cost of advice, or a full cash withdrawal is being made and the process is viewed as straightforward. Even so, guidance may be helpful in these cases to make sure customers have fully understood the risks. Investment Pathways certainly has a role to play in helping fill the advice gap, and making sure customers are aware of all their options and the risks of each.

Unsustainable withdrawal rates

For those taking a regular income, the question is, are customers doing so in a sustainable way?

For pots over £250k in size, over half are withdrawing less than 4% in regular or partial withdrawals each year, and only 14% are taking 8% or more. If we compare this with smaller pots, with less than £100k in value, then 58% are taking 8% or more a year in regular withdrawals. Perhaps they have other pension pots or income sources they can draw on? But assuming many do not, this does create some cause for concern. Overall, it seems that customers with smaller pots are drawing income at less sustainable levels, and it this group that is less likely to be accessing advice too.

To consider the sustainability of these withdrawal rates, we can consider a customer with a £100k pot, who withdraws £8k in the first year (8%). If a customer then proceeds to take £8k every year thereafter, they will run out of money after 16 years, if we assume an average investment growth rate of 3%. Given average life expectancy for a 65-year-old male is around 18.6 years, and 21.0 years for a female, this means many customers could end up exhausting their pension pot several years early, leaving them with a shortfall to meet from other means.

New solutions are required

Another challenge which the FCA are keen to address is the fact that many individuals are uncertain about the most appropriate investment choice for their drawdown policy and as a result, many end up choosing cash for its perceived safety. The Investment Pathways legislation is coming in to address this issue, but we believe that by implementing a strong pathways solution, providers can help their customers to deal with the other challenges.

It's clear that more needs to be done to engage customers when they access their pension pots, especially if they are doing so for the first time. For customers who aren't accessing advice, more needs to be done to make sure they seek guidance where possible. More could be done by the government to promote the use of Pensions Wise or MAPS, but providers can play a role too through Investment Pathways, which will create a new framework to support non-advised customers from February 2021. For a successful pathways implementation, it will be important to have engaging tools that help customers understand their options, and in particular, the risk of exhausting their funds early by either withdrawing too quickly or investing too cautiously.

To achieve this, we believe that the most successful Investment Pathways solutions will include:

• Clearly defined investment solutions which customers can understand for each pathway.

• A personalised view on each investment pathway option and what it will mean to a customer in terms of their own retirement income.

• Customer education and guidance around retirement income requirements and individual longevity forecasting.

Hymans Robertson have a range of engaging retirement planning tools for advisers and customers, including a new Investment Pathways Tool that supports providers in meeting the FCAs requirements whilst creating an engaging journey for customers.

Find out more about our Investment Pathways solution or book a demo here.