Steven Cameron, Pensions Director at Aegon
Recent statistics from the Financial Conduct Authority (FCA)* show that currently, ‘drawdown’ is three times as popular as buying an annuity. Here, rather than using your pension pot to buy an annuity, you keep your pension funds invested while drawing down an income which you can vary at any time.
While ‘drawdown’ has been available for many years, historically it was mainly used by those with larger pots who opted for drawdown over other options after taking professional financial advice. But since the pension freedoms were introduced, the number of individuals going into drawdown with smaller funds and without the benefit of advice has rocketed. This comes with risks to individuals and some pension providers won’t take on new customers who want drawdown unless they first take advice. Others will only offer this to customers who already have a pension with them. Because of the increased use of drawdown coupled with the risks, the FCA and the Government have introduced a number of new safeguards. The latest, investment pathways, comes into force on 1 February.
Here, Steven Cameron, Pensions Director at Aegon sets out what the new investment pathways are and what they’ll help with, but also warns that they won’t offer the personalised support available when taking professional financial advice.
What are investment pathways?
“From 1 February, customers with defined contribution pensions who’ve already decided to take a retirement income through drawdown rather than an annuity, but who refuse to take professional advice, will be offered new support from pension providers.
They’ll be asked to identify which of four retirement scenarios best matches their plans on using their pension funds over the next five years. Their pension provider must make available a range of four investment pathways designed to be broadly appropriate for these scenarios. It’s then down to the individual to choose whether to select one of the pathways or to pick from the wider range of investment funds on offer.”
The four scenarios are:
• I have no plans to touch my money in the next five years.
• I plan to use my money to set up a guaranteed income (annuity) within the next five years.
• I plan to start taking my money as a long-term income within the next five years.
• I plan to take out all my money within the next five years.
Cameron continues: “For some people, their plans may be clear and they may be able to identify a retirement scenario. For others, including individuals over 55 who may have lost their job as a result of the pandemic, it may be difficult to think as far ahead as five years.”
Who will investment pathways help and how?
“Some individuals approaching retirement who don’t want to buy an annuity and have decided on drawdown instead may never have made investment decisions of their own. Under automatic enrolment, most employees in workplace pensions make no active investment choice and instead are invested in a default fund. The regulator is concerned that some individuals who don’t take advice could then make particularly unwise investment choices, for example taking on too much or too little investment risk. What’s right for one person may be much less so for another depending on how much income an individual plans to take when, or if they are planning to buy an annuity at a later date. The idea behind investment pathways linked to retirement scenarios, supported by guidance offered by pension providers, is to help reduce the number of individuals who make particularly inappropriate investment choices.”
What won’t investment pathways do?
“Pension drawdown offers individuals huge flexibility to remain invested, potentially achieving further investment growth with the ability to choose how much income to take when, and reflecting changes in circumstances during retirement. But compared to the guaranteed income for life offered by an annuity, it comes with far greater personal responsibility and risk. In drawdown, decisions have to be taken regarding not just where to invest but also how much income to take out, and both these decisions should be reviewed regularly. Many will be relying on their drawdown pot to provide an income throughout their life, so taking out too much too early might mean their pot will run out before they die. And of course, none of us know exactly how long a life we have ahead of us.
“Investment pathways will not provide any help in deciding how much income to take. From an investment perspective, they will also not look at an individual’s full personal circumstances and attitude to investment risk, and unlike with advice, there’s no ‘personal recommendation’ of which pathway to choose.
“While investment pathways will offer some help to those who choose to ‘go it alone’, it’s really important to understand that they won’t replace the benefits of taking professional financial advice. There, an adviser will examine each individual’s personal circumstances and make a personalised recommendation on where to invest as well as how much income can safely be taken to last throughout life or meet other retirement objectives. Advisers can also review the best approach on an ongoing basis, reflecting changes in investment conditions or personal circumstances.”
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