Calling all advisers, have you answered the FCA’s call to action on retirement income?

Almost a decade after Pension Freedom Day, on 20 March 2024, the Financial Conduct Authority (FCA) published the results of a review into retirement income advice. The review focused on retirement income advice market functions, whether current planning firms consider clients’ specific needs in decumulation and whether advice in this area is suitable. Financial planning and advisers were therefore very much front and centre of the report.

An assessment of how firms deliver retirement income advice was long overdue. This is because the pension freedoms that were introduced in April 2015 triggered a dramatic shift in client behaviour. Almost overnight, the previously dominant annuity-based retirement structure was cast aside in favour of the more flexible retirement options that were now available.

The increased use of investment-based solutions to meet retirement income needs, however, meant investment and longevity risk for many were no longer borne by the annuity directly but by the consumers themselves. Because of this, three considerations underwrote the need for the review:

1. An understanding that moving from accumulation to decumulation marks a significant milestone. Flexibilities have increased exposure to investment and mortality risk, as opposed to a secure, guaranteed income for life.
2. Auto-enrolment has dramatically increased the number of employees who contribute to defined contribution (DC) pension savings. It is estimated that in 2024, the overall workplace pension participation rate for all employees in Great Britain stood at 82%. In all, 3m employees were saving via workplace pensions, a 0.9m increase compared to 2023.
3. Decisions for clients who are approaching or are in retirement have become much more individualistic and complex. Funding retirement not only involves considering levels of income needed, which investments to hold and where pensions remain invested, but also has to compete against differing client objectives - which may also include leaving a legacy.

The advice a client receives is all-important. Sound advice helps consumers make decisions that will enable them to meet their income needs sustainably in decumulation; poor advice, by contrast, could adversely impact client outcomes. The stakes are high. And not just for the clients but, as the review concludes, for advisers too:  

We are good, but can be better

As for the review’s findings, these were mixed. While some firms demonstrated strong consideration to clients’ needs and good outcomes, others did not. This was reflected in how firms were preparing (or not) for the Consumer Duty requirements that were due to come into force in July 2023 - based on a desk-based review sample, over half of the 24 firms had not taken the necessary steps to prepare for Consumer Duty.

The research uncovered the real risk of significant harm for clients through evidence of:

• Clients suffering a reduced level of income expected and/ or their funds run out too soon
• Clients paying unnecessarily high fees
• Clients investing in complex solutions with little understanding of the investment/ risk chosen, bearing little resemblance to their own risk and investment needs.

The FCA findings were not purely observational. They also set a clear expectation that firms move towards a more personal, ongoing and evidence-based retirement strategy. The below are five key areas that were identified for improvement across firms:

1. Income withdrawal – whether cash flow modelling or a withdrawal guide rate is used, it has to be tailored to the specific client’s current and future needs, circumstances and objectives.
2. Risk profiling – attitude to risk (ATR) and capacity for loss (CFL) need to be evidenced and consistent with objectives, customer knowledge and experience. There is an expectation, in the main, that these will change as clients move from accumulation to decumulation.
3. Advice suitability – incomplete files are a real concern, evidenced by loss of guarantees, penalties and unnecessary taxation. Poor quality fact finds are central to this.
4. Periodic reviews – if a client is paying for a service they must receive it. Increased awareness of vulnerability in decumulation clients and an understanding of what they are paying for, and how to cancel, are imperative.
5. Control framework – understand fully what a client has/ or has not in terms of their retirement schemes.

Improvement across these five areas will better place advisers to understand the client retirement journey and at the same time adhere to a key Consumer Duty pillar: avoiding foreseeable harm. And failure to evidence these considerations would not just impact the client but could result in closer scrutiny for firms too under the Consumer Duty regulatory framework.

Understanding client retirement journeys

Anticipating future needs is key to understanding what clients want. The outdated rigid approach of a fixed level of withdrawals is no longer the go-to solution for clients. That’s because clients’ needs can be complex. They may want to:

• Top up income to cover shocks borne through divorce, job loss, ill health or to fund extravagant lifestyle events
• Support adult children through essential needs or milestone events of a wedding or first home purchase
• Invest in other plans to fund debt repayment, property purchases and other savings vehicles
• Fund imminent or current retirement whether that be full or semi-retirement and can include annuities, drawdown strategies, or a mix of both.

Understanding when a client may need to make withdrawals from a portfolio and preparing in advance to accommodate these cash calls can help minimise sequence risk - the potential for withdrawals to have a negative impact on the overall rate of return available to the client.

A useful tool for tackling sequence risk is cash flow modelling. In conjunction with regular reviews, cash flow modelling helps address spending needs, though unpredictable events make precise planning difficult. Every client’s decumulation strategy is unique and must accommodate potential changes in spending patterns - active spending early on, followed by reduced or care-related expenses. Factors such as health, longevity, and investment influences can significantly affect the timing and nature of these financial needs, often differing from initial expectations.

Cash flow modelling must take all these into account. The acceptance that retirement generally starts with the active phase, followed by a more passive phase and sometimes, but not always, the later care support stage adds further credence to a more flexible approach to modelling sustainability in retirement.

Avoiding foreseeable harm

An integral part of the DNA within financial planning, avoiding foreseeable harm is the core responsibility underpinning any advice given, especially when it comes to retirement income advice.  How clients interpret advisers’ projections is key here - do these lack objectivity and offer an unrealistic outcome based on unjustified returns? Getting this wrong could render the suitability of recommendations moot, profoundly impacting the client.

As for unforeseeable harm, expect the unexpected. Modern-day retirements do not model well for predictable, steady income streams and the need to be cognisant to the longevity of need, market forces and the unforeseen capital events that invariably occur.

A call to action

The FCA accompanied the release of the review with a letter to adviser firms. The letter, which was addressed to Chief Executives, set out the FCA’s vision. This is centred on ensuring clients can:

• Get the help they want, at the time they want it, at a price that is affordable
• Invest with confidence, understanding the risks they are taking, and protections available
• Identify and access investments that meet their individual risk and circumstances
• Be better protected from scams.

This material is not tax, legal or accounting advise and should not be relied on for tax, legal or accounting purposes. Quilter Cheviot Limited does not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting adviser(s) before engaging in any transaction. (Registered office details in footer of webpage).