Bruce Moss, founder of fintech group eValue, said drawdown providers must go further than the Financial Conduct Authority’s “limited requirements” on investment pathways, and should put processes in place to stop savers unwittingly withdrawing an unsustainable level of income from their retirement pots.
He said failure to do this could see providers hit with complaints or even legal action.
Mr Moss said this was particularly an issue with investment pathway option three — taking an income within the next five years.
He said: “The problem mainly lies with option three at the moment. Without any information about the level of sustainable income that the pathway might be expected to support, not to mention how it might vary with investment outcomes, it leaves everyone exposed and people could complain against their provider.
“What is needed is not just to set this expectation at the outset, but also to provide regular updates — ideally annually or at times of severe market dislocation.”
Adviser view
Alan Chan, director and chartered financial planner at IFS Wealth and Pensions, agreed savers should be made aware of the impact of their withdrawal levels.
Mr Chan said: “I would view this as one of the biggest risks with non-advised drawdown — individuals withdrawing too much from their pensions and prematurely exhausting their pot.
“In our litigious society, it would not come as a surprise if said individuals then go on to make a complaint some years later, possibly with the help of ambulance chasers, and sought compensation from their drawdown provider for allowing it to happen.
“Individuals should be allowed to draw any income they want as long as they understand the longer-term impacts, so it would make sense if providers can issue some sort of warning letters if withdrawals are consistently above a certain threshold year on year and perhaps encourage them to take independent financial advice too.”
Meanwhile Ivor Harper, director at advice company Park Financial, said it was down to the investor to decide their own withdrawal levels and providers cannot stop people behaving in a way that is “irrational and against their own best interests”.
He said: “The best a provider can do is to ensure that annually, or with every change to the payment amount if sooner, it issues clear and unambiguous warnings about withdrawal rates that exceed prescribed levels — possibly with a strong recommendation to seek advice.
“It needs to be short, punchy and simple if it is to have any impact at all.
“Other than warn people of their potential folly, as the rules now stand, I fail to see what else providers can really do.”
How can providers help?
Providers are already required to send out various risk warnings and keep savers up to date with the performance of their funds, but it will be harder to tailor these to individual withdrawal levels, according to Tom Selby, senior analyst at AJ Bell.
Mr Selby said: “Although sustainability of withdrawals should clearly be front-and-centre for anyone in drawdown, it is not obvious how pathways can help non-advised investors with this challenge.
“Providers are already required to produce various risk warnings, as well as annual statements to inform customers of the performance of their fund, but whether or not a withdrawal plan is sustainable will depend on someone’s personal circumstances, assets and sources of income.
He added: “The thinking behind investment pathways in their current guise is fundamentally flawed. The four options providers will be required to present to customers are targeted at broad outcomes rather than risks, meaning investors could end up in something which is entirely inappropriate to their needs.
“Indeed, if investment pathways had been in place before Covid-19 struck it is almost certain providers would have been hit with a barrage of complaints by customers who had been shoehorned into investments which subsequently plummeted in value.”
Meanwhile, Steven Cameron (pictured), pensions director at Aegon, pointed out that investment pathways were not designed to and never can help identify a sustainable level of income.
He said: “Of course, different underlying investments may well influence the sustainable income, but this also varies by age and how soon an income will commence. Investment pathways will hopefully help individuals avoid particularly inappropriate investment choices, but they cannot replace personal financial advice.
“Periodically, there are proposals for rules of thumb around sustainable income levels. But these are also problematic because of different investment approaches, ages and health status. They could also be misunderstood by customers if after following the rule of thumb, and even more so without regularly reviewing their position, they run out of money.”
Mr Cameron added: “It is important the FCA and financial ombudsman are clear on the intentions behind, and the limitations of, investment pathways from outset.”
The FCA first proposed four pathways earlier this year after it found many consumers were solely focused on taking tax-free cash from their pensions and were “insufficiently engaged” with deciding how to invest funds that moved into drawdown.
The pathways include an option for consumers who have no plans to touch their money in the next five years and for those who plan to use their money to set up a guaranteed income within the next five years.
The regulator also proposed an option for consumers who plan to start taking money as a long-term income within the next five years and those who plan to take out all their money within the next five years.
amy.austin@ft.com
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