The Financial Conduct Authority (FCA) will roll out a new pension transfer and investment initiative this year. As well as offering higher levels of protection and guidance, these new reforms will simplify the pension investment process.
Before 2015’s pension reforms, UK pension regulations had remained relatively untouched for some years. The ongoing tightening of advice and guidance and the simplification of the investment process are a welcome addition to recent reforms. The changes will gradually come into force between February and October, in what is seen by many as a positive step. Therefore, you should begin to prepare yourself for the new pension landscape.
Raising the standard of pension advice in the UK
While much of the recent focus has been on the investment pathways initiative, it is worth noting future changes to pension transfer specialist (PTS) qualifications. Many PTS’s also hold comparable investment adviser qualifications, but this is not currently standard. While the investment pathways initiative has been delayed until February 21, changes to PTS qualifications will not come in until October 2021. Due to the impact of the Covid-19 pandemic, the authorities require additional time to update and amend current PTS courses and guidance.
The transfer of defined benefit pension assets has attracted significant criticism in recent years. Whether unaware of the long-term implications, or demonstrating an unhealthy appetite for risk, many pension holders have yet to feel the consequences of their actions. Regulations dictate that if you’re defined benefit pension assets are worth £30,000 or more, you will be required to take independent financial advice be transferring elsewhere. The expansion of adviser qualifications will reduce investor misunderstandings and complacency and help protect defined benefit pension rights.
Introduction of new pension investment pathways
Historically, many regulatory concerns in the pension sector have related to excessive risk. The introduction of pension investment pathways is a means by which the FCA is tackling the problem of overcautious investment by those in drawdown. The traditional path for pension fund investments tends to be a gradual reduction in the risk profile, as holders head for retirement. Many pension holders have been overcautious, switching a substantial portion of their investments into cash and quasi-cash assets.
Obviously, in volatile markets, a significant cash balance offers a welcome degree of security. However, many pension fund holders have switched too soon, are holding too much cash, and reducing their exposure to long-term capital appreciation. UK base rates currently stand at 0.1%, thereby cash on account currently offers little or no yield. If you consider inflation, each year the real value and spending power of cash in your pension scheme is falling.
An article on the Interactive Investor website highlights an FCA report regarding underperformance and reduced relative spending power. It concluded that those holding a balanced mix of assets over 20 years, instead of just cash, have benefited from a 37% increase in pension income. So, what is the FCA proposing?
Individuals in or about to enter drawdown
Under the new investment pathways initiative, those in or about to enter drawdown will be given three options:
- Consider investment pathways
- Continue to self-manage their investments
- Retain current investment risk/reward profile
It is fair to say that the FCA has simplified these options, and the process, as much as possible. If nothing else, these options will prompt the question to pension holders about how they wish to manage their assets from now on. The flexibility, which came about because of 2015’s pension reforms, will remain.
Investment pathway options
Pension companies will offer those who choose the investment pathways route four options. These will take in four broad objectives - note these will not be personalised to each individual - which include those:
- With no plans to access their funds in the next five years
- Expecting to purchase an annuity within the next five years
- Looking at long-term drawdown within the next five years
- Planning to withdraw all of their funds within the next five years
Each of these four options equates to a different investment pathway fund, in which pension fund assets will be invested. Overall, the idea of investment pathways has been well received by the industry and pension holders. However, several concerns have been raised, including:
- Inability to take into account an individual's circumstances, and additional assets - in effect adopting a one-size fits all approach
- A lack of flexibility with regards to an individual’s preferred risk/reward profile
- Potential risk of investment losses if forced, unexpectedly, to switch investment pathway funds
- The lack of one-on-one professional financial advice - no advice is given with the new investment pathway approach
In reality, there will never be just one solution which can accommodate all investor requirements. The introduction of investment pathways will, at the very least, ensure investors think twice before acting. It will also offer those looking to self-manage their pension assets several options, applicable to their long term goals.
Nothing can replace financial advice
The investment pathways initiative announced by the FCA is an interesting halfway house between experienced investors self-managing their assets, and those who depend on financial advice. It is essential to clarify that this initiative does not replace financial advice. The broad approach to the different pension funding initiatives is not personal. Could this create more problems further down the line?
The ongoing challenge of pension reforms
Since 2015’s major pension reforms, we have seen many additional changes. The introduction of a greater degree of flexibility has perhaps had unexpected consequences. Whether overcautious or over-optimistic, those who do not take a balanced approach to their asset mix could lose out in the long term. While the introduction of investment pathways has quite rightly attracted headlines, the tightening of advisory qualifications is also a welcome development.
Unfortunately, many people will not realise the implications of flawed pension fund investment decisions until it is too late. Whether looking at self-management, taking advantage of the investment pathways or depending on independent financial advice, there are potential long-term risks with both over-optimistic and overcautious approaches.
