The FCA is currently undertaking a thematic review to assess the advice consumers are receiving on meeting their income needs in retirement. It is expected that the regulator will publish its findings of this review in Q4 2023.
Given this, we thought it was an excellent time to garner the thoughts of M&G Wealth’s Director of Specialist Business Support, Vince Smith-Hughes, on what might be coming down the line with this review and what advisers need to consider in preparation.
Clearly there are implications here for advisers, especially following the recent introduction of Consumer Duty. In this exclusive Q&A, Vince talks to IFA Magazine’s Editor, Sue Whitbread, about what he expects to see from the review as well as broader issues around retirement income and regulation when it comes to adviser practice.
Sue Whitbread: Why is the FCA currently undertaking this thematic review of retirement income advice? What do you make of it and what might be under the spotlight?
Vince Smith-Hughes: I guess it should not be a surprise that the FCA are doing this review. They have talked previously about doing an ‘assessing suitability review number two’, which was going to focus on retirement income but it got cancelled because of COVID. This is the first opportunity that they’ve got to actually go and test the retirement income market since pension freedoms came in, in 2015. They’re going to regard it as a high risk area and will be likely to want to see what sort of client outcomes are being achieved. We are expecting to see the results of this being revealed in Q4 of this year.
Sue Whitbread: What key themes do you expect us to see in the retirement income review?
Vince Smith-Hughes: I’d suggest that we’ve got two really good indicators as to what we’re likely to see from it. The first one is that we had the DB scheme final rules – FG21/3 – back in 2021 which puts the final guidance on DB advice. I believe that there will be a lot of similar themes in there. We’ve also seen the 61-page questionnaire that the FCA is issuing out to advisers, which also gives some pretty big clues of areas of focus. I know the list is not exhaustive, but I’m thinking it’s going to revolve around a lot of the know-your-customer information specific for this market.
I’d be expecting it to include such elements as: measuring the client’s normal expenditure and whether that has been captured in their core income requirements? Has their other income and all the other plans outside of the pensions been identified and taken into account? Is the income clients are planning to take sustainable? Has it been stress tested with cashflow modelling?
Another area which I think is important, particularly now, as interest rates have been going up dramatically, is whether annuities have been considered for all or part of the client’s fund? Following on from that, has this option also been revisited when they come to do the review of the client’s income drawdown? I’d suggest that of particular relevance is looking at the impaired life and enhanced annuity market. It’s worth looking at whether clients might benefit initially when drawing benefits and again when being reviewed.
I remember from the DB review, one of the things that came out was overstating the advantages of income drawdown versus the DB pension, in for example flexibility and death benefits. I think this is very similar, the regulator will be looking for similar biases when comparing drawdown with an annuity. Of course, that’s all on top of other essential areas such as attitude to risk and capacity for loss.
Two additional things I would throw into the mix here. I think there’s going to be a strong focus on adviser fees, and particularly ongoing fees. We saw lots of questions in the questionnaire such as ‘what does your firm do for an ongoing review?’ – in effect what does it actually include? I think everyone acknowledges ongoing advice is very often appropriate in this space, it’s just advisers will need to be able to demonstrate why it is needed, that the frequency is appropriate and the review needs of their target market.
The other area is a focus on lifetime lending and what the adviser’s strategy is for this part of their retirement income offering. Whether dealt with in house or otherwise, it looks like advice firms would be well advised to have their process for this in place and documented.
All in all, I think there are many things that advisers need to consider and now is an opportunity to make sure ‘I’s are dotted and ‘T’s are crossed ahead of the review findings coming out.
Sue Whitbread: As you say, Consumer duty is now with us. How do you think that this affects the provision of retirement income advice for clients?
Vince Smith-Hughes: People sometimes talk about the thematic review and Consumer Duty as if they’re different things, but they’re totally linked. The FCA has actually said that the results will be an important indicator of how firms are effectively implementing Consumer Duty and providing good client outcomes.
In terms of Consumer Duty, there’s a requirement for a report to be produced by firms, no later than the anniversary of the first implementation of Consumer Duty, which means the end of July 2024. I think that’s really interesting when it comes to income drawdown, because an advice firm will need to include the results of the monitoring they’ve undertaken to look at the outcomes clients are getting, any evidence of poor outcomes, what they’ve done about it, how they’ve addressed any risks or issues etc. The market is very volatile at the moment, so I think it’s particularly relevant at the moment.
I’ve read quite a bit of information from the FCA where they’re talking about using data to demonstrate the results being achieved. I think that’s really important in the income drawdown space to be able to say, ‘let’s look back and see what results we are producing through interrogation of our MI system. I’d be looking to identify drawdown clients as a separate target market and feel confident in saying ‘these are the propositions we are using, these are the strategies we’re using for retirement income clients, and these are the outcomes we’ve achieved.’
I am focusing here on income drawdown, really because that’s the thing that typically needs ongoing monitoring by the adviser. If clients purchase an annuity from day one, then it’s much more straightforward. But I think you’ve got to look at the risks of income drawdown and say, ‘what are you doing to address these?’
This is not exhaustive, but advisers will have to consider longevity risk, investment risk, inflation risk, and sequencing of return risk, the last of these which is particularly relevant right now. Any changing circumstances of the clients are important too of course, and need to be addressed at review time or as they occur.
Sue Whitbread. You’ve alluded to the volatile markets when talking about Consumer Duty and the thematic review there, as well as today’s high interest rates. What should advisers be considering in relation to the provision of retirement income for their clients?
Vince Smith-Hughes: With markets proving to be so volatile at the moment, we’ve seen some fairly big falls in markets over a short space of time. The risk that brings to the fore for income drawdown is sequencing of returns risk. This is something which will be familiar to probably everybody who is reading this article. It’s basically taking income from a fund when the fund value has been depleted, and thus making it harder for the fund to recover – in short you’ve effectively crystallised the loss. It’s something that can be really damaging to an income drawdown portfolio.
In such cases, I think there are a number of things that can be done. First of all, you want to be stress testing via cashflow modelling at outset so the client knows the risks, and is aware of what the plan is should markets/fund values go against them.
In terms of the strategies advisers could use, there are a number of things.
If you have a client with a core income requirement, is it possible to meet that core income requirement within an annuity and have a drawdown arrangement as well for additional or ad hoc income? It doesn’t have to be an all or nothing situation.
In terms of sequencing risk, it might be that an adviser is using the ‘bucket approach,’ where you earmark funds to provide income at certain periods in time. That’s a valid strategy. Also a lot of advisers will tell me they only take ‘natural’ income from their client’s portfolio, so that protects the value of the units themselves, which I think is also valid.
You’ve also got to think about emergency funds if the markets do fall and maybe that can come from cash held within the drawdown or perhaps even outside of the pension temporarily. For example, you might well take the view that ‘the markets are falling, we’re going to take income from a cash ISA for several months,’ I think that’s a valid strategy in some circumstances. And of course at present, it’s not as if you’re parking that cash and not making any return on it.
Finally, the value of smoothed funds should not be overlooked. They can really help to iron out some of the day to day fluctuations in volatile markets.
There are so many different strategies which advisers can – and should consider – and these are just some of them that we’ve talked about here. And of course, none of them are mutually exclusive.
Sue Whitbread: How important is ongoing adviser diligence and vigilance – and also in being very thorough in documenting everything to prove that all relevant details have been assessed?
Vince Smith-Hughes: In terms of Consumer Duty, it’s really important. I’d suggest a good plan is to start with what you’d like in your annual report and work backwards as to how you get there. That’s because advisers are doing a lot of these things right already, and its just about proving it in a Consumer Duty world. This will inevitably mean having the right data/MI available.
Sue Whitbread: To finish off today, could you remind us of some of the ways that M&G Wealth can help advisers to find solutions to these issues? What tools and resources are available etc.?
Vince Smith-Hughes: Certainly, I’m pleased to say that there are a whole host of things where M&G Wealth can help advisers here.
For example, there’s a new retirement income checklist which has just been released, which is designed to help advisers make sure they have thought about and documented various aspects of retirement income planning.
There’s also Consumer Duty hubs from Pru and M&G Wealth Platform, which have a wide range of information and summaries on as well. One thing that comes to mind is a useful article from Pru which specifically looks at marrying client income and Consumer Duty, and talking about how you might want to create that part of your report to cover the risk of drawdown and what you’re doing about them.
PruFund, which benefits from smoothing, and recently added to the M&G Wealth Platform, continues to be a popular choice with advisers for their clients. There’s plenty of detail about PruFund since pensions freedoms began, which could be useful to have on your files to show that you’ve looked at the past history of using such a solution.
Of course, the M&G Wealth account managers are always on hand to provide advisers with a whole host of other information around this space. We’ll continue to do our very best to help advisers get through the review and achieve the right outcomes for their clients. Now, perhaps more than ever before, steering clients to be able to make the right choices as regards their retirement income must be of the utmost importance. We will continue to strive to support advisers with resources, services and products which allow them to deliver excellence in financial planning.
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About Vince Smith-Hughes
Vince is Director of Specialist Business Support at M&G Wealth. He has worked in the financial services profession for almost 40 years and has previous experience as an IFA as well as holding senior pension roles at Clerical Medical and Winterthur Life. Vince is an experienced platform presenter at industry events and a regular contributor to trade and national publications on all matters relating to retirement issues and is a Fellow of the PFS. Vince is married and lives in East Anglia.
