How Britain has behaved since pension freedoms

Data from the Financial Conduct Authority (FCA)’s July 2017 Retirement Outcomes interim report reveal more than 1m defined contribution (DC) pension pots have been accessed since the pension freedom and choice regime came into force in 2015.

The majority of these pots – 64 per cent – were less than £30,000 in value – a tiny amount when compared with the value of the state pension, which the FCA put at approximately £200,000.

Assuming someone takes state retirement at 67 and lives for 25 years, at £8,094 a year, the value of the state pension (based on current levels) is £202,350.

It’s not hard to understand why people with small pots have been taking the money as cash: the FCA report shows 54 per cent of all pots were completely encashed. Of those pots which were completely taken in cash, 90 per cent were from pots that were £30,000 or less. 

But not all of this money went on Lamborghinis or Land Rovers or even a souped-up Ford Fiesta. Much of this, the FCA says, went into other savings vehicles, such as Isas. 

And then there is drawdown. The FCA paper stated: “Drawdown has become much more popular: twice as many pots are moving into drawdown than annuities. 

Many people have taken the tax-free cash and some people do not understand that they have moved into drawdown. William Burrows

“Before the pension freedoms, more than 90 per cent of pots were used to buy annuities.”

But this is changing. The flexibility drawdown offers – to remain invested while drawing as much income as needed – perhaps even within the current personal annual allowance of £11,500 – is attractive. 

Andrew Tully, pensions technical director for Retirement Advantage, comments: “The FCA stats show a huge shift from the world before pension freedoms.

“Drawdown used to be the preserve of the wealthier retiree, but that is no longer the case, as for all pot sizes in excess of £30,000, drawdown is the leading solution.

“People are attracted by the flexibility of drawdown and, for many, the key attraction is the potential to cascade pension wealth through the generations in a tax-efficient way.”

However, this has led to some potentially problematic consumer behaviour, the City watchdog has highlighted.

According to the FCA: “Our research shows very low levels of shopping around and data from the Association of British Insurers (ABI) shows that 94 per cent of non-advised drawdown sales were made to existing customers. 

“This suggests limited competitive pressure to offer good deals.” 

As a result the City regulator says it plans to investigate further whether consumers are getting good value when they move into drawdown without taking advice.

Investment choices

According to figures from pension provider Aegon, the investment choices people are making post-pension freedoms have not been significantly “risk free” in retirement. 

Steven Cameron, pensions director at Aegon, comments that so far, decumulation customers are mostly investing in the same vein as in their accumulation stage, whether they are in drawdown or not.

He notes: “So far, customers are investing in much the same assets as they were investing in while saving for retirement, and are only dialling down the risk slightly”.

The average breakdown for those entering drawdown is as follows: 

Multi-asset strategies – 45 per cent.
Equity growth – 18 per cent.
Bonds – 15 per cent.
Equity income – 12 per cent.

According to Mr Cameron, this is broadly mirrored by the strategies employed by non-drawdown investors: 

Multi-asset strategies – 46 per cent.
Equity growth – 24 per cent.
Bonds – 12 per cent.
Equity income – 8 per cent.

For him, this is a worry. “This isn’t a particularly mature market,” he says. “We expect to see advisers and their clients increasingly tailor their investment approach to reflect the requirement for low-risk, regular income.”

Sipp, Ssas, drawdown and transfer

It is worth making the point here that not all pension clients have rushed to drawdown. 

Femi Folorunso, senior consultant at Mattioli Woods, comments: “Clients within our self-invested personal pensions (Sipp) and small, self-administered schemes (Ssas) have not suddenly rushed to request a full flexi-access drawdown of their pension income.”

According to Mr Folorunso, the impact of the pension freedoms has been “low key”, with only a handful of clients using flexi drawdown where the “flexibility of access to liquidity is required, above annual sustainable drawdown limits – to meet life expenses”.

He says the firm is also finding that some clients with defined benefit schemes have been approaching Mattioli Woods to review the feasibility of transferring into a defined contribution scheme. 

However, he adds: “The rationale for giving up a guaranteed income from a final salary has to stack up in terms of a client’s specific circumstances, and cannot be based solely on managing income in retirement.”

The great unknown

Another concern flagged by the FCA is the lack of knowledge, information and advice being sought by consumers before heading into drawdown.

The FCA report also states: “Many consumers buy drawdown without advice but may need further protection to manage their drawdown effectively. The proportion of drawdown bought without advice has risen from 5 per cent before the freedoms to 30 per cent now. 

“Drawdown is complex and consumers need to manage longevity and investment risks by choosing appropriate investment and withdrawal strategies. There is a question about whether further support and protection is needed to manage drawdown effectively.”

William Burrows, retirement director for Better Retirement, comments: “It is true to say drawdown is the new default, since annuities are out of favour at the moment.

“Many people have taken the tax-free cash and some people do not understand that they have moved into drawdown.

“The more enlightened (or those with really good advice), will have phased their tax-free cash to avoid higher-rate tax.”

Yet the future may not be as bleak as these statistics suggest. Fiona Tait, technical director for Intelligent Pensions, comments: “The evidence suggests most people are not using it to withdraw large lump sums or excessive income.

“The majority are younger retirees, aged between 55 and 65, and may have a need for temporary or top-up income, rather than a sustained income for life.”

She points out that, as the average initial drawdown fund has fallen in value, this may mean people will still have earned income and other pensions that will be payable at a later date.

However, she accedes: “There are undoubtedly those who only have small savings, and would rather cash them in rather than purchase ongoing income.”

How providers have behaved

Annex 2 of the FCA’s Retirement Outcomes Review is quite telling. Of the 55 providers it analysed offering retirement income products in the year immediately after pension freedoms came in, the majority – 28 firms – offered drawdown only. 

Three offered only annuities and none offered just blended products. Some providers offered both drawdown and annuities.

Figure 1, taken from the FCA document, shows the vast majority of available products being provided – possibly also marketed – are drawdown products. 

Only nine providers created a form of blended product that sought to combine the best features of annuities with the best features of drawdown.

As shown in Figure 1, the majority of providers offered drawdown only (28 firms), followed by a number of providers offering both drawdown and annuities (15 firms). 

What is a blended solution? 

Blended solutions in a nutshell sound like a great idea. Although the detail is more complicated, and depends on the provider and the individual, a blended solution can be delineated thus: 

•    It is an annuity and a pension drawdown, with a cash account, held in one, tax-advantaged wrapper. 
•    Daily costs can be covered by a stable income stream on the one hand while, from the drawdown fund, investors can risk some of their pension pot in the investment markets.
•    Income withdrawals can be started, stopped and varied. Income can be redirected into the plan.
•    This product can accommodate those with medical or lifestyle problems as it offers enhanced annuity rates.
•    It can also help people who want a competitive guaranteed annuity rate.
•    Blended drawdown also provides comprehensive death benefits. Under current rules, on the drawdown side, the fund can be inherited in full (although subject to tax after age 75) while on the annuity side a guarantee can be put into place for up to 30 years which may provide ongoing income for the surviving spouse.
•    A 100 per cent spouse’s benefit can also be provided.

While a flexible combination of annuity and drawdown sounds like it would be popular, data suggests at the moment this is still a nascent area.

The FCA’s data comprised more than 170,000 sales and the regulator made it clear how minuscule the sales of blended solutions can be.

The paper said: “They are a niche product with only 0.1 per cent of the total sales.”

Yet Mr Burrows comments that people who have taken income as well as moving into drawdown “seem to have made sensible choices” – suggesting for some, a blended solution could be the most appropriate route for them.

How advisers have behaved

A spokesman for LV comments: “An adviser’s role is to help their client throughout their retirement planning to achieve the right level of capital and appropriate level of income, with appropriate certainty, balanced with flexibility.”

Kim Lerche-Thomsen, founder and chief executive of Primetime Retirement, says advisers have been well placed to meet the growing numbers of people needing help with their retirement options post-freedoms.

He comments: “Advisers can use their knowledge of the retirement market to assess which available products best meet the requirements of their clients.”

However, Mr Lerche-Thomsen adds that, because the range of options and products offered has expanded post-pension freedoms, this can make it more challenging for advisers.

Therefore, he adds: “It is vital advisers keep abreast of industry trends and changes in the market to find the best solution for their clients.”

simoney.kyriakou@ft.com