The Financial Conduct Authority has published final rules requiring non-workplace pension providers to offer consumers a default investment option and issue warnings about the risk of holding cash holdings.
The rules, which were published alongside new proposals for pension dashboards, aim to protect non-advised consumers who end up making poor choices for their non-workplace pension because of the wide range of complex investment options available.
They require non-workplace pension providers to offer a ready-made, standardised “default” investment solution to be made available alongside other investments. The FCA said the default options must be fair value and designed to meet the needs of the typical non-advised consumer choosing them, while providing a better pension outcome for consumers choosing a default option than they could otherwise achieve on their own.
However, the FCA has backed away from plans to mandate that default funds incorporate ‘lifestyling’, whereby investments are automatically shifted into lower-risk investments ahead of an assumed retirement data, following opposition from the pensions industry.
Tom Selby, head of retirement policy at AJ Bell, welcomed the new rules: “While non-advised customers who choose to invest in a non-workplace pension are more likely to be engaged than people who are automatically enrolled into a workplace pension, there remains a risk some will either subsequently become disengaged or struggle to make good choices about where to invest their pension.
“Making investment choices simpler and providing nudges where potentially poor decisions are being made could therefore lead to more people having bigger retirement pots. Having a simple default fund solution could be a useful part of the non-workplace infrastructure, but it was important firms were given flexibility to design such a solution to meet the needs of their customers.
“It is therefore welcome that the FCA has acknowledged this in its policy statement and backed down from proposals to essentially mandate ‘lifestyling’ in these default strategies.”
Andrew Tully, technical director at Canada Life, echoed the sentiment: “It’s a positive move that the regulator has listened to warnings and recognises that lifestyling will not be appropriate for all investors. Most lifestyle strategies are designed with wholly buying an annuity at a specific age and that is not what most retirees are doing and won’t be the best outcome for many, so we shouldn’t be requiring defaults to be designed in this way.
“People need advice, failing that to be led down a path suitable to their individual needs, taking into account many will phase into retirement, use drawdown, or withdraw funds as lump sums. As savers’ circumstances change, so their retirement choices and investment decisions should change and adapt. Saving for retirement and decisions around generating income in retirement is never a perfect linear choice that can be chosen many years before retirement and left alone.”
Helen Morrisey, senior pensions and retirement analyst at Hargreaves Lansdown, added: “Many people in non-workplace pensions are more than happy to choose their own investments but for those who don’t have this confidence then the use of default funds can help. Choosing investments may act as a barrier to groups such as the self-employed or those looking to consolidate in setting up a pension and so offering a single default fund will aid decision making and improve outcomes.
“It is good to see the FCA has listened to industry concerns and there is flexibility baked into the rules. For instance, the rules still give providers the flexibility to develop further solutions for those who are more confident making investment decisions so those who need the support receive it, while others retain the flexibility to choose. We also welcome the fact that it is not mandatory to adopt a lifestyling approach in these funds if it does not meet the needs of the target market.”
Challenges re cash erosion warnings
Under the rules, savers will also be warned about the risk of inflation eroding the value of significant levels of cash holdings, after inflation recently hit a 40-year high. Pension providers will be required to send cash warnings where someone has more than 25% of their pension held in cash or cash-like investments; the amount of cash is greater than £1,000 or the saver is more than five years away from being able to access their pension pot.
These reforms will be introduced for non-workplace pension customers in 12 months’ time.
Steven Cameron, pensions director at Aegon, welcomed the new requirements for firms to send additional cash warnings, but warned that the move could be “challenging” for some and should be balanced with an explanation of when cash holdings may serve a purpose.
Cameron said: “The rules will require firms to provide generic illustrations of how much a £10,000 investment will lose in value over 10 years. With the Office for Budget Responsibility predicting a sharp fall in inflation in coming years, basing a 10-year projection on current historic highs could be very misleading. Similarly, using a 0% interest rate when cash savings rates have risen and are expected to continue to do so again seems overly pessimistic. Furthermore, the OBR expects inflation to be negative in some future years, which would mean even with 0% interest, cash savings would grow in real value. This raises major questions over what a warning about the ‘dangers’ of inflation for cash savers would look like then.
“The FCA has left it for each firm to decide if based on market conditions they believe it is ‘the wrong time’ to issue a cash warning. This will be very challenging at a time when few can predict where markets will move next. Deferring a communication for three months might benefit some customers if they then didn’t move out of cash before a market fall. But if markets actually rose, deferring investing could mean some customers lose out, leaving providers open to being judged with the benefit of hindsight.”
