In this valuable analysis, Richard Parkin, Head of Retirement for BNY Investments, explains below how and why it is so important for advisers to review their processes in line with the changing regulatory environment.
The FCA originally intended to review the retirement income advice market back in 2019. A combination of workload and responding to the pandemic meant the review wasn’t started until last year, with the findings published in March 2024- nearly five years after the review was first mooted. Was it worth the wait? There’s certainly plenty for advisers to digest, and I suspect most firms will find areas of their retirement income advice process that will have to change.
Key findings of the FCA review
The review was accompanied by a Dear CEO letter to advice firms setting out five areas where the regulator believes action is needed as follows:
1. Withdrawal Strategies: The FCA found that the approach to determine income withdrawals approach was not always based on individual circumstances and/or based on assumptions that were not justified or recorded.
2. Risk Profiling: Little or no differentiation between an accumulation and decumulation approach. Insufficient allowance for customer knowledge/experience and not enough focus on capacity for loss.
3. Fact-Finding: Failure to capture enough information on assets and expenditure, future objectives and circumstances, and income needs to demonstrate suitability of advice.
4. Ongoing advice: Some evidence that clients were not always receiving a periodic review when they had paid for it. Also, the regulator reminds firms that the annual review should be a reassessment of suitability, not just an update on the client’s financial position.
5. Control framework: The FCA found firms were often holding inaccurate or insufficient records to assess customer outcomes and track whether periodic reviews were being delivered.
While the review found many shortcomings in the advice given, the FCA has responded to these constructively. The findings report lays out in detail the key objectives for firms in delivering retirement advice. For each it provides commentary on the review’s findings, what the regulator expects to see and gives examples of good and poor practice. While advisers will need to consider the detail of how they respond to the review, it’s difficult to argue that the regulator’s expectations are not clear. By working systematically through the points raised, firms should have a clear idea of what they need to do.
Ensuring suitability of investment
The review doesn’t explicitly state that advisers need to operate different investment approaches for clients in retirement. However, it does make it clear that risk for retirement income clients is likely to be different from those accumulating wealth and that capacity for loss is a key consideration when assessing this. The regulator also reminds us that the investment solutions used need to be aligned to customer’s risk profiles and needs. Taken together these points suggest that different investment approaches are likely to be needed for decumulation versus those used for accumulation, something that not all firms do today.
At BNY Investments, we have built a framework for retirement investment that considers what differentiates retirement income clients from those that are accumulating wealth and what this means for retirement investment. For example, retirement income clients are likely to have much more specific objectives than those saving for retirement which means we can think about investment and risk in terms of the achievability of these objectives. This takes us beyond just thinking about volatility which tends to underpin traditional risk assessments. Another differentiator is that retirement clients have limited resilience. That is, they are less able to recover from setbacks than those saving for retirement which means they will be more wary of losses. Finally, retirement income clients face a sequence of returns risk. Losses early in retirement can adversely impact the sustainability of income and therefore need to be managed correctly.
There is no single right approach to retirement income investing but we believe it requires a more thoughtful balancing of risk and reward than is traditionally adopted when investing during the accumulation phase. The focus becomes less about maximising return and more on delivering the return the client needs to achieve their objectives with consistency and certainty. This might be achieved by using strategies that are expected to have lower downside such as quality and income equity strategies, by using active management to mitigate downside risk and fixed income strategies to support income or protect against losses. Now that yields have returned to healthier levels, we are seeing renewed interest in income generating strategies that can address a range of retirement risks.
The future of retirement income advice
As well as responding to the FCA review findings, firms are starting to think about how their retirement advice offerings need to develop. In our research published last year, we found firms were expanding beyond just advising on retirement income to offer a more holistic retirement planning service, including later-life care and financial coaching. The move towards a more goals-based planning approach certainly seems to be supported by the FCA review findings.
Next year sees the first Gen Xers hitting age 60. While this generation’s core retirement needs are likely to be the same as the boomers – to maintain their standard of living and not run out of money – their financial circumstances are likely to be very different. In general, their pension provision will be more fractured and less generous. Few will have the security of defined benefit pensions. They are likely to have housing wealth, and this may need to be more heavily relied upon as part of retirement planning. Family structures are likely to be more complex and Gen Xers may face greater demands from ageing parents and children who are struggling to get onto the housing ladder. All these factors are likely to increase the need for retirement savings to generate sustainable income rather than providing a top-up to existing secure income sources, as they do for many of the current generation of retirees.
The next few years are therefore likely to see significant changes in the delivery of retirement advice. One thing seems certain though, and that is that there is no shortage of demand. Retirement is a growth business and those who can adapt to the changing landscape will be better positioned.
