A default drawdown product could breed more pensions complacency.
All income-drawdown providers should be required to offer a default product for savers who don’t take control of their retirement planning, says an influential cross-party group of MPs.
A default drawdown product, with charges capped at no more than 0.75% a year, would protect savers who don’t engage with the process or even shop around for the best product, says the House of Commons’ Work and Pensions Committee. However, there
are concerns that such arrangements would lead to even larger numbers of savers failing to take control of their retirement planning.
The debate comes three years after the introduction of the pensions freedom reforms, which made it much easier for savers to withdraw money directly from their pension funds in retirement, rather than buying an annuity. While the reforms have proved successful, there is a danger of savers losing out because they don’t fully understand all of the options available to them.
The Financial Conduct Authority (FCA), the City regulator, has found that as many as a third of drawdown savers get no advice on which products to use or how to arrange their pension investments. That has prompted concerns that savers could run into problems later on in retirement – potentially running out of pension cash, say, or investing inappropriately.
A default drawdown plan with strict limits on charges and a risk-averse investment strategy could mitigate this risk – and would be similar to the default investment plans routinely offered to savers as they build up their pension funds. The use of these default plans is especially prevalent among younger savers and those contributing relatively small sums to workplace pension schemes.
However, some in the industry are bitterly opposed to the introduction of default drawdown products. They argue that many default funds have performed poorly for pension savers – and that designing a one-size-fits-all product for savers in retirement with very different personal circumstances would be much more difficult than for those still in the accumulation phase of pension planning.
The significant numbers of savers in default plans prior to retirement could also be an indicator of what is likely to happen if default drawdown plans are introduced, with even larger numbers of people opting to take no financial advice in the potentially mistaken belief that a standard product is appropriate for their needs.
The cost of poor engagement
Millions of pension savers invested in default pension funds may be missing out on higher investment returns, according to research published by broker Hargreaves Lansdown.
The company looked at the return on the nine largest default funds run by workplace pension providers. It then surveyed 12,000 active members of workplace pensions, and looked at the average return on the ten funds most commonly chosen by them for their pension funds.
They found that these active members had been able to achieve an average annual return of 14.3% a year. By contrast, the typical default fund had delivered only 9.4% a year over the same period.
The shortfall stems from the fact that most default funds are “multi-asset” funds that have less exposure to global stockmarkets and therefore take less risk than pure equity funds. Given that global stockmarkets have doubled over the past five years, this has led to some
of the default funds underperforming (though of course, if equity markets had crashed, this result may well have been reversed).
The firm’s data does suggest, however, that staff should engage more in managing their pension funds. In particular, multi-asset funds are unlikely to suit younger investors with long time horizons.
Tax tip of the week
With the new financial year come more changes to the tax system. Firstly, the amount of dividends that you can earn in a tax year, an allowance that was only introduced two years ago, has now been cut from £5,000 to £2,000. This cut will cost basic-rate taxpayers with £5,000 of dividend income an extra £225, higher-rate taxpayers £975 and additional-rate taxpayers £1,143. Next, landlords can now only deduct 50% of mortgage interest payments as a business expense.
This deduction will be removed entirely by 2020, with landlords instead granted a tax credit worth 20%. The “residence nil-rate band” – an allowance that excludes a portion of the value of a family home from inheritance tax – has gone up to £125,000 per person. Finally, households in England could see the biggest rise in their council tax for 14 years – councils have been given the ability to increase bills by up to 6%.
Fast Pension customers fear for their savings
Pension company Fast Pensions and five other associated companies went into provisional liquidation last week, prompting fears for the security of the savings of several hundred members of workplace pension schemes.
The company ran 15 pension schemes on behalf of employers, with a total of around 250 staff affected, and it is also understood to have recruited savers via advertisements on social media and through financial advisers. The company was last week ordered to cease trading by the High Court.
The Insolvency Service is now advising savers with money invested through the company to take legal advice, contact an independent financial adviser or to speak to the Pensions Advisory Service (the free helpline funded by the government).
In theory, savers’ cash should have been ring-fenced, so that their money would not be at risk in the event of the company suffering financial difficulties. Savers’ losses might also be recouped from the Financial Services Compensation Scheme, which pays out when customers of regulated financial services businesses lose out because their provider has gone bust.
For now, however, the picture remains unclear, with the High Court appointing the Official Receiver to investigate the state of the company’s finances. The company has seen more than 20 complaints to the Pensions Ombudsman upheld against it over the past three years, with savers complaining that they had stopped receiving annual statements and had found it difficult to get information on the state of their savings. Some savers have also reported difficulties with getting access to their cash when making requests to transfer their money to an alternative pension scheme.