Savers are set to be catapulted into the complex world of income drawdown this April without the information and knowledge to compare products and shop around for the best deal, experts warn.
The new freedoms coming into force from April are expected to lead to more people entering drawdown contracts than ever before.
However, the FCA’s retirement income market study focused on making it easier for savers to shop around for the best priced annuity, not drawdown, prompting warnings that providers could look to use drawdown as a profits “honey pot” following the decline in annuity sales post-Budget.
Unlike annuities, savers are free to quit drawdown contracts but inertia and the prospect of exit charges could stop them moving to better value deals.
A recent Age UK report warned average savers in “typical” high charging drawdown contracts could run out of money a decade early. So will the first wave of post-freedoms savers sleepwalk into products that will seem expensive in years to come? And is a charge cap the answer?
Pension providers say the FCA’s long awaited retirement income market study is “out of step” with the post-freedoms landscape and could lead to people being pushed toward annuities.
In addition, they warn consumers will find comparing drawdown products all but impossible.
Standard Life head of pensions strategy Jamie Jenkins says: “The market study was of a different time, when annuities were compulsory, so it focuses on how to get the best annuity, which is now just one of a variety of options.”
One of the remedies proposed by the FCA requires firms to make it clear how their quote compares to others on the open market, rather than just alerting customers to the potential benefits of shopping around.
In Aegon’s response to the regulator’s consultation, Aegon regulatory strategy director Steven Cameron warns: “Improving shopping around won’t help customers assess options other than annuities and if designed poorly, could wrongly give the impression that annuity is the default or ‘right’ option.”
But he adds that extending the comparison rule to other income options will be difficult using a single figure.
He says: “Comparisons on any single metric may not tell the full story, as the FCA has highlighted for other comparison websites. As well as initial and ongoing charges, other features which could be compared include fund choice, self-help tools, the availability of any guarantees within the drawdown contract and whether it can be used to facilitate adviser charging if the customer wishes to pay for initial or ongoing advice in this way.
“It is difficult to see how the proposal would work for any more flexible forms of annuity that may become available, particularly those offering lump sum payments in certain circumstances.”
Part of the problem is the range of charging structures used by providers, says LV= head of retirement propositions Philip Brown.
“With annuities you can get a real-time binding quote but drawdown charges work in a variety of ways and you need to know which products have what fund offering inside them,” he says.
“If you wanted to compare four different drawdown contracts you would need to know which funds were contained within each one and there’s huge maintainence involved in knowing which funds are available at any one time.
“Then there’s the charges. Some people charge basis points for a wrapper charge with or without a cap, then there’s a fund charge and you might also have transaction charges. With drawdown, it means you’re not always comparing apples with apples.”
But Brown says the development of simplified drawdown products, with less investment choice, should make it easier to compare propositions.
However, former Which? financial services policy team leader Dominic Lindley predicts many customers will be defaulted into providers’ products without realising it.
Jenkins says the company will not look to default savers into drawdown and will instead leave customers’ money invested.
But Lindley warns: “If customers ring up and say they want access to some of their pension then they’re going to be in drawdown and the provider will then levy the charges that apply.
“People aren’t suddenly going to become super informed and begin asking for lower investment charges, that’s just not realistic.
“For some of these companies the back book represents a moderately lucrative source of income at the moment in the form of poor annuity rates. Drawdown charges is one way they could look to recoup some of what they’ve lost with annuities.”
Lindley’s report for Age UK on the implications of the freedoms modelled the potential impact of high charges on an average pot. Based on an initial 2 per cent set-up charge, a 2 per cent annual management charge and a £150 annual administration charge, a £29,000 pot would run out by age 75, a full decade short of the average life expectancy of a 65-year-old woman.
But Age Partnership head of retirement strategy James Dean says there are options available with far lower charges. The firm is offering a non-advised service which allows people to set up a basic drawdown plan for 1.25 per cent, plus a platform charge of 0.35 per cent and a service charge of 0.25 per cent.
“We can do the low charges because we’ll allow people to do so on a non-advised self-select basis but we won’t add a minimum charge on that service,” he says.
“We need to add a charge on advised services because there are certain regulatory costs we have to get through but if someone has a low-value fund then there are low cost solutions and that is the gap we are trying to fill.
“Occasionally we might get bricks thrown at us about being potentially irresponsible so we counter that by giving people lots of information and making sure they validate decisions they are making so they understand the implications.”
A survey of 80 occupational schemes conducted by actuaries Xafinity revealed last month that just 2 per cent are planning to offer members full flexibility, including drawdown.
But a fifth of schemes say they will help members move to a scheme that will allow them to use the new income options.
Other non-advised offerings are bound to be revamped in time for the April deadline but providers are being tight lipped about their plans.
Hargreaves Lansdown is currently reviewing its charging structure for flexible drawdown, Money Marketing understands.
Currently customers pay £295 to enter the contract, £10 to alter the payment amount or frequency of payments and £25 for one-off payments, all subject to VAT.
In addition, investors who want to close their platform account are hit with a £25 penalty, while those wanting to re-register with a rival platform must pay a fee of £25 per holding.
Providers such as Royal London, Standard Life and Old Mutual Wealth have previously said they will allow so-called “insistent” customers to enter drawdown contracts without advice. However, these customers will be limited to a restricted choice of investments.
But Money Marketing can reveal Zurich will not be following suit. Non-advised customers and members of its corporate schemes will have the same options available to clients who use the advised platform, according to head of retirement proposition Rod McKie.
However, Aviva head of pensions policy John Lawson says the days of non-advised drawdown products could be numbered.
He says providers’ claims that simplified versions could be developed to serve the mass market are misguided as drawdown is “inherently complex” and could be labelled as such by European regulators.
He says: “It’s inherently complex and involves a complex trade-off between investment risk, life expectancy, things that are beyond people. Even advisers might find it difficult.”
Lawson thinks a recent FCA paper on the boundaries of retail investment advice “hinted” that drawdown could be officially labelled a complex proposition, meaning advice would be mandated.
He says: “You could probably do execution-only drawdown in the old rules, but it looks like future rules might extend the scope of Mifid to cover things like drawdown.
“Mifid II is likely to push towards the advised end of the spectrum, essentially saying complex propositions need to be advised.”
He compares it to the restrictions, recently confirmed by the Government, that mean members with defined benefit pensions will only be allowed to transfer out of schemes without taking advice if their pot is worth less than £30,000.
Dealing with the 0.75 per cent charge cap on auto-enrolment default funds has been one of the biggest challenges for pension providers in the past 12 months.
It is due to come into force this April yet there are already calls for it to be extended to post-retirement products, drawdown in particular.
TUC pensions policy officer Tim Sharp says: “There’s bound to be a need for control on costs, currently drawdown is a retail product and charges are high. The question is how you do that and you shouldn’t rule out a cap. But that’s not the only mechanism.
“If trust-based schemes begin to offer pathways you’d think institutional buying would bring down costs. But the Government should be willing to step in and look at charge capping.”
A Labour-commissioned review into retirement products led by the Pensions Institute director David Blake first raised the question of the cap and is due to report on its findings in the summer.
A Department for Work and Pensions spokesman says: “The Government has no plans at present to implement a charge cap on drawdown products but will be monitoring the market carefully as the new freedoms come into effect.”
However, Alliance Bernstein managing director of sales and client relations Tim Banks warns all retirement income solutions would need to be covered if a price ceiling was introduced.
He says: “We would urge caution about isolating the drawdown charge cap debate without looking at the alternatives, like annuities or withdrawing all the funds in cash, and their appropriateness for providing an income in retirement or the resulting tax implications.”
If a cap is introduced, it will be against the wishes of advisers, a retirement report by The Platforum is set to reveal. The upcoming report will say just one in four advisers back a cap on retirement products, either because they disagree on principle or are not convinced it could practically be applied.
Ray Black, managing director, Money Minder Financial Services
Extending the 0.75 per cent charge cap will not work for smaller funds moving into drawdown. It wouldn’t be profitable for insurers to offer a product with that cap. For someone with a £20,000 fund that will only generate £150 a year to provide all ongoing services to the clients, admin and ad-hoc withdrawals. And if it’s not profitable it won’t be offered.
Flexible drawdown charges
Hargreaves Lansdown – Non-advised customers pay £295 to open flexible drawdown, £10 to alter the payment amount or frequency of payments and £25 for one-off payments. Fee for closing an account is £25, while re-registering with another platform costs £25 per holding. All payments are subject to VAT. All charges are under review.
Tilney Bestinvest – Non-advised customers pay £150 to open flexible drawdown, £100 annual charge for income payments (after tax-free cash) and £25 to change payment amount or frequency or for one-off payments. All payments are subject to VAT.
Barclays Stockbrokers – Non-advised customers pay £75 to set up a flexible drawdown contract. There is an annual £100 annual admin charge, and a £75 charge to transfer out, close the Sipp for trivial commutation. All payments are subject to VAT. Post-April charges have not been announced.
Legal and General – No charge to take 100 per cent of fund as cash or to transfer. New default pension fund – Retirement Income Multi-Asset Fund – has a 0.35 per cent AMC. Post-April admin charges and irregular payment charges are under review.
Old Mutual – Drawdown fees were removed in January. Customers are charged a single platform fee based on a percentage of assets across their Isa, Collective Retirement Account, CIA (Collective Investment Account) and CIB (Collective Investment Bond).
Zurich – No explicit drawdown fees for clients on its advised platform or Retirement Account in addition to the platform charge and annual fee.
Axa Wealth – No explicit drawdown charges through the Elevate Pension Investment Account. For the standalone Sipp, clients pay £150 to enter flexi-access drawdown, £150 for full UFPLS withdrawal, £50 per UFPLS withdrawal. There is a £150 annual admin fee for flexi-access, no charges for ad-hoc payments and no exit payments. AMC varies depending on which funds were used. All charges are under review.
The new pension flexibilities could result in thousands of consumers paying excessive charges for income drawdown. The Government should expand the scope of the charge cap to prevent another scandal.
At the moment, drawdown is the exception, utilised by those with larger pension funds who normally take advice. This will change following the introduction of the new flexibilities. In future drawdown will become the norm, used by many with smaller pension funds without advice.
Some things won’t change – consumers approaching retirement will still find it difficult to grapple with life expectancy, jargon and complexity. They may feel overloaded with choice and can be influenced by how the options are presented to them.
These factors mean that there will be a strong force of inertia in the market. Consumers using drawdown could face a baffling range of administration, investment and platform charges. Whilst high quality financial advice can help consumers find the best deal, this advice itself will have a cost and the changes in the market will result in more consumers accessing drawdown without advice.
Inertia and complexity means consumers are at risk of paying higher charges. Competition won’t work to drive down charges and protect consumers from being ripped off. Responsible companies may provide their customers with good value. Others could see their inert back-book customers as a honey pot which they can use to make extra profit.
Shopping around for drawdown will be very complicated for many consumers. We could spend years trying to rewrite the literature sent to consumers at retirement to encourage them to shop around and explain how to do it. Instead, the Government should act now by extending the scope of the charge cap to income drawdown.
Dominic Lindley is an independent consultant