by Jonathan Watts-Lay, Director, WEALTH at work
The pension freedoms changed the face of retirement income options for many members of defined contribution (DC) schemes. Individuals now have to think about whether they want an annuity, drawdown, cash or a combination of options; when to access their pension; if it is better to use savings first before drawing their pension; and so on.
However, it seems many don’t really understand the consequences of these options: Our Pension Changes Survey results 2017 show that 48% of employers believe that their employees are not aware of the various retirement income options available to them at-retirement. Also, findings from the Pensions and Lifetime Savings Association (PLSA) found that of those who were planning on using income drawdown, some pension savers thought there were no risks with drawing a regular income from their pension, and over half thought it would provide a guaranteed income in retirement. Yet despite these misunderstandings, only a minority of people paid for advice.
It also found that some very large funds had been fully cashed out; presumably triggering hefty tax bills and a shift towards more self-managed income drawdown, i.e. without the help of a regulated adviser. Additionally, it found that many had taken income from their pensions to simply re-invest into cash, stocks or shares (even after an income tax liability was incurred) – no surprises that HMRC has stated it is collecting far more in tax from individuals cashing in their pots than it anticipated.
It’s also been reported that pension fraud and in particular pension scams are on the rise. There were plans to introduce new measures to tackle cold calling, limiting pension transfers and making it harder to open fraudulent schemes, but this is now on hold until the outcome of the General Election. However, even if these measures are implemented, it won’t be enough for determined scammers.
As we can see, whilst the pension changes offer a great deal of flexibility they also carry many pitfalls and risks, especially around tax and investment loss. The best way to deal with this is for individuals to receive financial education, guidance and advice.
De-mystifying guidance vs advice
Firstly it’s important for employers and employees to understand the difference between guidance and advice, as receiving guidance and education is not the same as obtaining ‘regulated advice’. It can be a common area of confusion but without regulated advice an employee will not receive personal recommendations based on what is suitable for them, and they won’t have the same level of consumer protection if anything should go wrong.
It’s not surprising that individuals are confused. For example, the Citizens Advice Bureau and the Pensions Advisory Service are the two services running Pension Wise – neither of which can actually give employees regulated advice on their choices. With names like these involved, individuals can be forgiven for the confusion over who is able to offer regulated advice and who can give generic education and guidance.
To remove some of this confusion, individuals should think about it in terms of what they ‘could’ do and what they ‘should’ do. For example, education or guidance tells employees what they ‘could’ do, whereas regulated advice tells them what they ‘should’ do. We must focus on making the distinction.
If employees only receive education or guidance, at the end of that process they still have to make a big decision about their pension and indeed other savings which may contribute to their retirement income – employees will need to decide if they really are confident about doing that on their own, or if they think they need regulated advice.
Think of it in terms of buying a kitchen. It’s an expensive item to buy, and having spent thousands of pounds on your new kitchen, you wouldn’t then fit it yourself – for a comparatively small cost, you’d get an expert to do it. If you do it alone, and don’t fit your kitchen correctly, things could start going wrong – and that’s the situation you can end up in with your pension.
You’ve been saving for years, and then you get the education and guidance on the choices you can make, but when it comes to implementing those choices are you going to do it yourself or get expert regulated advice?
The more flexibility there is, the greater chance of people making the wrong choice – but there’s also a myth surrounding the cost of taking regulated advice that needs to be dispelled.
The FCA consumer panel demonstrated in their research that many employees who bought annuities without regulated advice suffered because the commissions they paid were often just as high, if not higher than paying for regulated advice, so there is no cost-saving there. Also and perhaps more importantly, if they make the wrong choice, there is significantly less consumer protection.
We need to remove the myth around regulated advice – because it is not necessarily any more expensive than any other option and you also have greater consumer protection in the event of being poorly advised.
Regulated advice is holistic: it will take into account your personal situation and that of any partner, and also all your assets and savings – not simply your pension pot, but also ISAs, shares and so on. An Adviser should then give you, based on your risk profile and what you’re trying to achieve, an appropriate recommendation about the choices you should make.
A helping hand
Plans are in place to roll out The Pension Advice Allowance, which will allow individuals to withdraw £500 tax-fee from their defined contribution pensions (at any age and up to three times, but only once in a tax year), to help them pay for the cost of regulated financial advice for their retirement. It was due to be launched in April this year but has been put on hold until the outcome of the General Election.
It’s critical that individuals realise the importance of taking financial advice when making important decisions about their retirement and anything that encourages employees to do so has to be a good thing. However, many employees don’t realise that it is possible to receive financial advice without having to pay for it up-front – therefore keeping valuable savings in their pension to grow further and then only paying if they decide to act on what is recommended.
Employers and trustees are starting to realise they can save employees money by using a retirement expert to offer advice to their employees, on a ‘try before you buy’ basis. This means the employee receives advice with a full written report but only pays if they accept the recommendation in the report; this could be to cover, for example, a drawdown plan for retirement or to consolidate legacy pensions into one place.
I really can’t see a reason why employers wouldn’t want to offer this – it’s a ‘win win’ situation for all.
Are you ready?
Employers need to be prepared for the fact that they will have staff asking what their options are in the lead up to and at-retirement – and they have to be prepared with an answer to that. The time has now come for employers to know how to support employees with all their choices and processes. Crucially, employees must know the difference between the ‘could’ and the ‘should’ around their retirement income options. There’s a four step approach that employers and trustees are now beginning to put in place to help their employees. This four step process can be provided by the new breed of retirement specialists such as WEALTH at work.
The first step is to provide employees with financial education and guidance. This is normally paid for by the employer and can help employees understand what they ‘could’ do; it gives employees a fuller picture of their sources of retirement income and helps them understand any tax implications and other considerations such as health and longevity.
This drives the second step in the process: helping employees understand what they ‘should’ do by providing access to regulated advice. This can help employees understand their personal financial situation and provides detailed recommendations of the best options to suit their financial circumstances. This stage is normally paid by the employee but as mentioned before the actual advice costs are only incurred if the employee wants to implement the recommendation, at which point they know the exact cost of doing so.
The third step is ensuring that employees can implement their retirement strategy in a cost-effective way.
Finally, the fourth step is to involve a retirement service provider who will look after an employee not only at the point of retirement but throughout their retirement. Only around 20% of individuals buy a lifetime annuity at present. Almost all others will need ongoing guidance and advice. As retirees get older and need more support to make decisions this is a crucial part of service provision.
Supporting employees early and helping them to follow a four-step approach to financial education, guidance and advice, retirement income implementation and ongoing support will mean that they get the most of the money they’ve saved throughout their working lives.