Since the introduction of major pension reforms in 2015, all defined contribution (DC) pension scheme members over the age of 55 have had free rein over how they manage their retirement savings. They can choose to withdraw cash, buy an annuity - or opt for income drawdown, where they can to continue to invest and grow their pension savings while drawing down cash as required.
To date, income drawdown has proved hugely popular with pension scheme members. Over 435,000 drawdown arrangements were entered into between October 2015 and March 2018. In the six months to March 2018, inflows into drawdown grew 27% compared to the same period a year earlier.
While those figures demonstrate members’ appetite for drawdown, the Financial Conduct Authority (FCA) has become increasingly concerned about the charges within some products, the fact that 32% of savers are entering drawdown without taking any financial advice and that 33% of those that don’t take advice are invested in cash like investments.
To address the issue, the FCA released series of policy and consultation papers in early 2019. The papers identify three solutions:
- Earlier and more concise communication of retirement options and risks
- Clearer communication of charges
- ’Investment pathways’ in non-advised drawdown products (i.e. those sold without advice). These will be a small number of well-designed investment solutions which aim to meet four retirement income objectives. Investing in cash would only be permissible as an active choice
How can DC trustees approach drawdown?
For many DC scheme trustees, deciding how to approach drawdown requires a balancing act between the needs of scheme members and the scheme’s resources. A small handful of single-employer trust-based schemes have chosen to offer drawdown within the scheme, but this is relatively rare.
From a member’s perspective rigorous governance around and in-scheme solution provides confidence that their savings are being well managed. Schemes can offer a consistent ‘to and through’ approach to building up and managing withdrawals from a member’s savings pot, simplifying decision-making and improving communications. Crucially, it means members aren’t left on their own to research a complicated product market and risk making a decision that could erode years of good quality pensions saving.
Trustees are bound by the same rigorous governance requirements for drawdown as they are for accumulation. They must make sure they have a suitable governance framework in place to manage drawdown effectively, savings must be invested appropriately and must offer good value for money for members. Good outcomes in drawdown rely on the ability of trustees to deliver these effectively. If a scheme’s drawdown solution is poor, then the outcome for members will also be poor. Many trustee boards have concluded that extending their scope to offer a drawdown arrangement is a step too far.
So what can trustees do to enable better decision making?
The most hands-on approach is for trustees to choose a third-party partner, or partners, to offer drawdown products to members, possibly in conjunction with financial advice. This means members are not researching the market from scratch. It provides an easier option than managing drawdown within the scheme, but members benefit from trustee due diligence and buying power.
Selecting and monitoring drawdown providers is not without cost and risk to trustees. Liability needs to be clearly communicated to members. Trustees may therefore find that offering access to a preferred adviser, or panel of advisers, is preferable to offering product specific recommendations.
Of course, trustees could leave members to research drawdown (and other) options and concentrate on providing information to enable better decision making.
Trustees should consider if communication of options at age 50 and every 5 years thereafter, in line with the FCA’s new rules from November 2019, will help. The trustees we have spoken to think it makes sense, and we expect the Department of Work and Pensions will consider aligning disclosure regulations.
The FCA’s proposal to introduce investment pathways should help members make better investment decisions if they choose a personal pension as their drawdown solution. We’ll need to wait and see if occupational pensions such as Master Trusts follow suit.
Members will still need to decide whether drawdown really is the right option for them and what type of product best suits their needs. Regardless of whether trustees choose to provide drawdown in-scheme, work with preferred providers or leave members to make their own decisions, good quality communications, a holistic approach to pension freedoms and clear ways to access to financial advice are vital ingredients.
Members may be invested in drawdown for 20 years or more, so making the wrong decision can easily undo the hard work of trustees in driving performance in accumulation. Doing nothing really shouldn’t be an option.