The Financial Conduct Authority (FCA) said a default investment strategy for personal pension customers would help cut through complexity faced by customers who do not take advice.
A consultation paper released on Thursday (25 November) said non-workplace pension customers have to choose their own investments from an increasingly wide range of options. This complexity can make it hard for some customers who do not take advice to choose investments that meet their retirement needs.
The default option would, the regulator said, need to be “an appropriately diversified basket of investments and take account of climate change and other ESG risks”.
It added that, as a customer approached retirement, their investments would be changed to “lessen the impact of any market downturn on their savings”.
The proposals would also put additional responsibilities onto providers. They would be under an obligation to warn customers holding high levels of cash and “prompt them” to consider investing in other assets with the potential for growth.
The FCA said its aim was to ensure pension savers have as big a pension pot as possible at retirement.
The regulator’s executive director for markets Sarah Pritchard said: “People spend decades working hard to build up a pension to support them in retirement, and we want their savings to work just as hard for them. These proposals will ensure that customers who don’t take financial advice can benefit from a professionally designed investment strategy, and reduce the risk of their retirement income being eroded by inflation.
“The proposals form part of our wider work on pensions which is designed to ensure that customers are better supported throughout their pension journey.”
The consultation is open until 18 February 2022.
The proposals said non-workplace pension providers should offer a ‘default’ investment option to new non-advised consumers.
This would be a “professionally designed investment strategy could deliver substantially better outcomes for those motivated enough to know that they need a pension, but who lack the experience or time to choose the right mix of investments”.
A further requirement would be to “issue cash warnings to consumers with sustained and potentially inappropriate levels of cash in their non-workplace pension”.
It explained: “Cash warnings would show how cash savings are at risk of being eroded by inflation and prompt consumers to consider investing in other assets with the potential for growth (such as a default option, if available).”
Pensions markets are a priority area for the FCA. It said its work on non-workplace pensions is part of its aim to improve outcomes across all types of pension products, working jointly with The Pensions Regulator.
Canada Life technical director Andrew Tully said: “Helping non-advised customers make good investment decisions, and not simply hold pension funds in cash over the long-term, are sensible suggestions from the FCA.
“However, it is important these changes have minimal impact on the advised market, where advisers help clients make investment choices appropriate to their individual circumstances. It also seems a little odd that the FCA suggests default funds should include lifestyling. Many clients will move into drawdown as they start to access their pension, and lifestyling may not be an appropriate choice in those circumstances.”
AJ Bell head of retirement policy Tom Selby added: “With inflation threatening to rampage through the economy, ensuring savers with a long-term time horizon invest their money sensibly is hugely important.
“While people who choose to invest in a non-workplace pension have by definition exhibited a level of engagement, there is a risk that some will either subsequently become disengaged or struggle to make good choices about where to invest their hard-earned retirement pot.
“In a worst-case scenario, they will end up shoving all their pension in cash and risk their money being eaten away by inflation. Having a default fund which is broadly suitable while also issuing warnings to those who invest in cash over long time periods could therefore help improve outcomes.”
Selby cautioned: “Care will need to be taken in ensuring engaged customers who were planning to build a retirement portfolio based on their circumstances are not encouraged to instead simply go for the ‘easy option’ of investing everything in a single default fund that might be less appropriate.
“The FCA has taken a pragmatic approach to how the default fund should be offered to people, insisting only that it should be ‘prominent’ in communications, and allowed for flexibility in the design of such funds.
“This should help ensure the reforms are introduced in a way which can genuinely help savers.”
Selby also said the provider disagreed with the regulator’s assertion that ‘lifestyling’ – a concept based around reducing the risk of investments as people approach a selected retirement date – was likely to be appropriate for most people.
“The majority of savers now choose to enter drawdown and stay invested in retirement, and so reducing risk ahead of this point will make little sense in many cases,” he explained. “Indeed, the idea of basing your investments around a set retirement date ignores the fact retirement is flexible for many people, rather than a specific point in time.”
The impact of inflation
“Inflation is an eroding force on people’s retirement pots, particularly when they invest in cash 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,” said Selby.
Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said the proposals were positive and could bring “real innovation”.
However, she added: “We must not forget the provision of high-quality guidance is also vitally important in empowering people to make more informed investment decisions throughout their retirement planning journey. People’s needs change and with the right education we can ensure they are able to make the appropriate ongoing changes to ensure they reach retirement in the best financial shape possible.”