Around 100,000 people a year could be saved from losing out on pension income when they go into income drawdown, following new proposals from the Financial Conduct Authority (FCA).
The regulator previously expressed concerns about the state of the retirement income market, finding that people were at risk of holding their funds in investments that will not meet their needs.
Here, we take a look at how income drawdown works and how effective the FCA’s proposals will be at helping consumers.
What is income drawdown?
Income drawdown is a way of taking money out of your pension pot to live on in retirement.
It was introduced in 2015 under the new pension freedoms and allows you to take up to 25% of your pension savings tax-free.
You can only start using income drawdown once you hit the age of 55 and have a defined contribution pension.
The short video below shares more information about how income drawdown works.
Why is the FCA making changes?
In June 2016, the FCA launched the Retirement Outcomes Review (ROR) to investigate the state of the retirement income market following the introduction of the pension freedoms.
One of the key findings in the review was that consumers didn’t really understand how income drawdown worked and how their pension pots were being managed.
Overall, the FCA found that one in three people who went into income drawdown were unaware of how their money was being invested.
To make income drawdown less confusing and help get consumers more engaged with their pension pots savings, the FCA set out several proposals and recommendations, some of which will come into effect as early as November 2019.
- Find out more: what the pension freedoms mean for you
4 proposals that could affect your pension pot
We’ve rounded up four proposals, made by the FCA , that could change the way you deal with your pension pot and help boost your returns.
1) You’ll be offered new ‘investment pathways’
The FCA’s review found most consumers were ‘insufficiently engaged’ with decisions around how to invest their pension.
To help people take an active role in how their pension pot is invested, the FCA will introduce four new investment pathways that firms must offer customers who enter income drawdown.
This means that if you take tax-free income from your pension pot, you will be offered a choice between four objectives for the remaining part of your pension investment.
Your provider will then offer the best solution for how your pot should be managed based on this choice.
The FCA opened a consultation last week for providers to give feedback on this proposal and will issue an official policy statement on how it will work in July 2019.
- Find out more: how to invest income drawdown
2) Your pension pot won’t default into cash
If you want to get the best return on your pension pot over the long term, it’s important that it’s invested in a variety of assets classes such as equity funds, gilts and bonds and cash or cash-like assets.
The FCA found that 50,000 customers, who didn’t receive advice, currently have their pension pots only invested in cash or cash-like assets, meaning they are losing out on significant returns.
When someone takes cash from their pension pot, firms will often offer the option of moving the whole pot into a cash investment. Overall, 94% of customers who accessed their pots without taking advice accepted the cash option, compared with only 35% of advised customers.
To combat this, the FCA is proposing that providers should not be allowed to move a pension pot into cash unless the customer actively tells them to do so.
Details on the implementation of this proposal are expected to be announced later this year.
- Find out more: income drawdown – making your money last
3) You’ll get your first ‘wake-up’ pack by age 50
‘Wake up’ packs are sent out by pension providers to help inform you of your options for retirement income when the time comes.
Currently, these packs are sent out four to six months before the retirement date you’ve selected. The FCA’s review found that the best time to send these packs is when a person hits 50 and it would be ‘unhelpful to delay the first ‘wake‑up’ pack any later than this.’
The new introductory wake-up packs will be kept as simple as possible, consisting of a single page document which summarises the key options available to you.
This change will come into effect on 1 November 2019.
- Find out more: can I take my entire pension pot in one go?
4) Provider charges will be made clearer
Currently, all pension providers must give you a key features illustration (KFI) each time you go into drawdown.
A KFI is a regulated document that has to be given to customers when they start a new investment. It gives you examples of how your pension pot might perform in different economic conditions and also includes information about fees and charges.
KFI’s are quite a lengthy read and can often cause confusion, so the FCA is requiring all providers to make sure that each KFI comes with a one-page summary at the front.
This summary must also clearly outline fees and charges.
The FCA expects this proposal to come into effect by 6 April 2020.
- Find out more: should I take a lump sum from my pension?
How effective will these changes be?
The FCA’s proposals are aimed at making pensions easier to understand and manage.
Some, however, believe will more must be done to ensure that consumers who don’t take professional advice are well-informed and make investment decisions that will benefit their pension pot in the long term.
Steve Webb, Director of Policy at Royal London said: ‘The FCA proposals are a small step in the right direction because they should help to ensure that people do not simply sleepwalk into letting their retirement pot be invested in low-yielding cash. But there remain concerns about outcomes for non-advised customers under pension freedoms.’
In particular, there is an issue around people who withdraw their entire pension pot in order to access tax-free cash and then simply dump the balance of their pension pot into a cash Isa or a current account.’
Which? has previously called for the government to follow through on its plans for a pensions dashboard, which would allow people to see how much is in their pension pots.
You can find out more about our campaign for better pensions.