The future of drawdown

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The FCA has set out its proposals for changes affecting the non-advised sale of drawdown products. These proposals give important insight into the FCA’s thinking, and suggest some possible implications for the market for advised products too.

On 28 June, the Financial Conduct Authority (FCA) issued a consultation paper that sets out their proposals for regulating the market for non-advised drawdown products. The main proposals concern the creation of three investment pathways. Consumers would be “guided” towards one of the pathways upon entering into drawdown, depending on their intended use of the funds being invested. While oriented towards non-advised consumers, the proposals have several consequences (both explicit and implicit) for the advisory market. The paper contains many laudable aspects, but as with any regulation throws up the potential for unintended consequences.

Pension freedoms: a double-edged sword

The consultation has its roots in the introduction of pension freedoms in the UK from 2015, which enabled consumers to tailor their retirement solutions to their own particular circumstances. This led to an increase in the demand for flexible drawdown products, where consumers decide how much income to take from their pot each year. However, the pension freedoms also imposed on consumers a decision – with important long-term repercussions – that very few are equipped to deal with. As a result, there is a critical need for consumers to seek advice (or some form of guidance) when considering their options.

There are several aspects of the consultation paper that we believe will make a positive contribution to outcomes for non-adviser customers, namely:

• Guarding against pension providers offering cash as a default option at retirement
• Creating choice architecture at retirement to guide consumers towards appropriate investment decisions
• Issuing regular reminders to consumers to review the ongoing suitability of their investment choices as their personal circumstances and financial needs evolve over time.

Can investment pathways provide the answers?

At the same time, there are a few proposals that might benefit from further clarification. The paper proposes three pathways, depending on whether consumers intend to (1) generate a stable income, (2) take all money out in the short term, or (3) draw income on an ad hoc basis. While we support the use of choice architecture in shaping the consumer’s journey, we believe strongly that this should take the form of guidance and be very clear that it is not advice. Nor should it create an obligation for the consumer to follow a particular course of action.

Moreover, the design and implementation of these pathways needs careful thought. Even if the pathways are intended as a guide, there is the danger that consumers perceive an indicated pathway as a strong recommendation. Instead of encouraging engagement at the point of retirement, the proposals seem more likely to drive people towards thinking less about their options. Individuals’ retirement objectives are likely to be complex and evolving, and it is unlikely that a choice of three options at retirement will capture this complexity.

As such, we believe that the criteria for establishing the pathways could be developed. The consultation paper focuses on intended use of funds. However, there are a number of additional factors that might also influence the choice a consumer makes when entering into drawdown. Among these are consideration of their other sources of income, their state of health and their ability to tolerate a short-term loss of capital. We therefore propose the creation of an ‘attitude to retirement’ tool that guides non-advised consumers towards an outcome that is more akin to a risk-profiled fund.

Broadening the umbrella of advice

The paper asks whether the pathways could be extended to advised consumers. We would caution against this. Advised customers benefit from holistic needs assessments, which take account of unique personal circumstances that are beyond the scope of simple rules. If anything, we recommend investigating how advice could viably be provided to a wider audience – for example through a tiered service model to suit people’s means and pot sizes. The benefits of appropriate, bespoke advice at retirement (and where necessary thereafter) cannot be understated.

A further point is the impact of regulation on innovation. The paper rightly says that innovative solutions are called for to address the complex needs of consumers at the point of entering into drawdown. We have some concerns that, if regulation is too prescriptive it will impede creative product design, lead to conformity and ultimately constrain the choices available to consumers.

Ultimately, any regulation needs to strike a balance between protecting consumers’ interests and encouraging innovation to create the products that consumers need. The FCA’s initial proposals are encouraging and with some refinements should improve outcomes for non-advised customers.

For investment professionals only. VitalityInvest is a trading name of Vitality Corporate Services Limited. Vitality Corporate Services Limited is authorised and regulated by the Financial Conduct Authority.