A pathway to a successful retirement?
The Financial Conduct Authority (FCA) published its final findings of its Retirement Outcomes Review  which looked at how the retirement market has evolved since the introduction of pension freedoms in April 2015. Since April 2015 to September 2017, over 1.5 million DC pension pots have been accessed, with twice as many pots used for drawdown than to buy an annuity. A third (32%) of these were accessed without advice, compared to 5% before the freedoms.
The FCA believes consumers need more support and protections when accessing their pensions and are consulting on its proposed recommendations.
Its research found that around one in three consumers who have gone into drawdown recently were unaware of where their money was invested. More than 60% of consumers not taking advice were not sure or only had a broad idea of where their money was invested. They also saw providers ‘defaulting’ consumers into cash or cash-like assets as an issue as well as the broad range of charges.
Charges also came under scrutiny with the FCA citing a lack of competitive pressure, causing consumers to pay too much in charges (non-advised charges ranging from 0.4% to 1.6% between providers).
A pathway to success?
In its handful of recommendations to address the need for greater consumer protection, the FCA suggested Providers should offer three ready-made drawdown investment solutions (‘investment pathways’) within a simple choice architecture. These three pathways broadly reflect the needs of members (1) wanting their fund to provide income in retirement, (2) wanting to take all of their fund in a short period of time and (3) keeping the money invested over a long period with occasional access to these funds.
So what factors should be considered when designing these strategies?
Below we have set out three key considerations when considering the design of these strategies. This is based on our experience of designing drawdown strategies and assessing the suitability of them on behalf for Independent Governance Committees (IGCs)
- Put yourself in the member’s shoes
In our experience, understanding whether the consumer wants to leave a proportion or all of their fund behind at the point of death is crucial in designing the investment strategy. Why? This impacts the level of risk the strategy needs to take e.g. someone looking to leave the majority/all of their fund as part of their inheritance will require different investment objectives to someone who needs to exhaust their fund for living expense s during retirement.
- Asset allocation – trading risk and return
Our framework for assessing funds suitable for drawdown seeks to understand a fund’s balance between risk and return. Interestingly, we have seen many funds (much like the FCA’s findings) that simply do not take enough risk. These funds are inherently conservative and do not consider that the fund is likely to require a meaningful return, particularly if it’s a consumer’s sole source of retirement income.
- Mitigating sequencing risk
Establishing the right rate of withdrawal is difficult. Each member will have different objectives and the previously assumed safe withdrawal rate of 4%, as outlined by American financial planner Bill Bengen in 1994, is no longer deemed sustainable as it is too simplistic, particularly in periods of market volatility. As such an investment strategy needs to consider how it will protect or be adjusted in periods of increased volatility to protect a member’s accumulated fund.
The investment strategy is one (important) component that affects an individual’s retirement outcome. As if designing the sophisticated investment strategy wasn’t easy enough, it needs to be explained and illustrated to a consumer in a simple and transparent manner with an appropriate guidance and advice wrapper.
So what does this mean? The investment pathways are a great initiative, but how they are designed and implemented by product providers will have the biggest impact on the outcomes of members.
 Bengen, William P. (October 1994). “Determining Withdrawal Rates Using Historical Data” (PDF). Journal of Financial Planning: 14–24.