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FCA ‘lifestyling’ default plans risk hard-wiring inertia and leading to poorer outcomes for non-workplace pension savers

Tom Selby, senior analyst at AJ Bell
Tom Selby, head of retirement policy, AJ Bell
  • The FCA’s consultation on ‘Improving outcomes in non-workplace pensions’ closed on Friday 18 February
  • Non-workplace pension providers could be required to offer non-advised customers a default fund that incorporates ‘lifestyling’ under the regulator’s plans
  • AJ Bell argues lifestyling – where members are automatically ‘derisked’ as they approach retirement – is from a ‘bygone era’ where most savers bought annuities
  • Furthermore, offering savers a single default fund risks hard-wiring inertia and potentially leading to poorer investment returns
  • Instead, AJ Bell believes offering a small range of risk-managed, multi-asset funds would lead to better retirement outcomes for non-advised customers in non-workplace pensions
  • FCA also urged to give firms flexibility when trying to reduce the number of savers holding cash over the long-term

Tom Selby, head of retirement policy at AJ Bell, comments:

“After a decade of relatively benign inflation, surging global gas prices combined with the re-opening of economies around the world has seen prices in the UK spike to a 30-year high. Indeed, inflation is expected to rise still further in 2022 and peak at over 7% in April.

“In this context, ensuring savers with a long-term time horizon invest their money sensibly – in part to combat the deleterious impact of rising prices – is of paramount importance.

“And while non-advised customers who choose to invest in a non-workplace pension are clearly more likely to be engaged than those 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 made could therefore lead to more people having bigger retirement pots.”

A single default fund is not the optimal solution

“Having a default investment solution could therefore help improve outcomes but a single default fund which incorporates lifestyling is not the optimal solution.

“The danger with offering a single default is that people who might otherwise have engaged will simply opt for the easiest option. This could mean people end up investing in a sub-optimal fund for decades.

“You can get an idea of the impact this could have by comparing the long-term performance of the ABI Mixed Investment 40 to 85% shares sector, containing older default funds, with the IA Global fund sector, the most popular sector with retail investors.

“Over the past decade £10,000 invested in the ABI sector would have delivered a fund worth £20,964 compared to £31,420 invested in the Global fund sector. Over 30 years £10,000 invested in the ABI sector would have returned £76,480 versus £101,990 in the Global fund sector.*

“In short – the most popular sector for retail investors making an active choice significantly outperformed funds in a sector primarily containing investors not making an active choice.

“This is likely because default funds by their very nature have to be lower risk to take into account the varying needs of those who invest in them. And in trying to please everyone, they often leave large numbers of people out of pocket.

“Instead, AJ Bell believes providers should have flexibility to create their own investment solutions designed for the types of non-advised customer that use their products. This would allow firms to offer a small range of risk-managed funds to better suit differing customers’ needs.”

The case against lifestyling

“The FCA is proposing that firms should build ‘lifestyling’ into the design of non-workplace default investment solutions.

“The idea of lifestyling was originally based on someone converting their entire pension into an annuity at a set retirement age – usually state pension age.

“However, since 2015 the retirement income market has flipped, with most people entering drawdown and keeping their pot invested.

“The extra flexibility created by the pension freedoms means people access their pension at different points in time and at different rates, meaning there is no clear point in time to de-risk a default towards.

“If someone is de-risked inappropriately – either too early or too late – this will lead to sub optimal retirement outcomes. Both will inevitably happen under the FCA’s plans.

“A small range of risk-managed funds, combined with education and nudges at appropriate ages could help non-advised customers implement their own de-risking strategy to suit their individual circumstances and needs.

“This could have the added benefit of boosting engagement among savers who plan to enter drawdown.”

Cash warnings

“We agree with the intention behind the FCA’s plans to require communications to be sent to non-workplace pension savers who hold large chunks of cash for long periods of time. Holding too much of your pension in cash can lead to disastrous outcomes, particularly over the long-term.

“Take someone who has a £50,000 fund invested in cash paying 0% interest over 20 years. If inflation runs at 2% a year over that period – the Bank of England’s official target – in ‘real’ terms it will be worth just over £33,000.

“To put that another way, the corrosive power of inflation will have reduced the value of their pension by over a third.

“However, rather than being prescriptive around when and how providers should deliver cash warnings, we believe the FCA should make excessive cash holdings a ‘Key Risk Indicator’ and then monitor providers by the number of customers who hold excessive cash.

“This approach would be measurable and allow firms to target warnings as appropriate to their customer profile.”

*Source: Morningstar:

ABI Mixed Investment 40 to 85% shares (Older default funds) IA Global fund sector (most popular sector with retail investors) Gain in pension pot size from IA fund investment
 

10 years to 31 Dec 2021

Annualised return 7.7% 12.1%
£10,000 invested £20,964 £31,420 +50%
 

20 years to 31 Dec 2021

Annualised return 5.8% 7.4%
£10,000 invested £30,897 £41,912 +36%
 

30 years to 31 Dec 2021

Annualised return 7.0% 8.0%
£10,000 invested £76,480 £101,990 +33%

 

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