The FCA’s rushed second line of defence rules for pension providers are failing to stop savers making potentially disastrous decisions, exclusive research shows.
An in-depth independent survey of Royal London customer behaviour, seen by Money Marketing, reveals the overwhelming popularity of taking an entire pension pot as cash.
But it also shows a significant number of people plan simply to leave their pension savings languishing in low interest rate bank accounts.
Many pension providers deliver the regulator’s retirement risk warnings on paper, rather than over the phone, online or face-to-face.
Fears are growing that the regulator will need to boost consumer protection yet again or risk thousands paying too much tax, running out of money too soon and seeing their money dwindle away through poor rates of return.
Dash for cash
Data collected by Harris Interactive on 800 Royal London customers who have accessed the freedoms since May shows 69 per cent had taken their whole pension pot as a cash lump sum.
In addition, around a quarter (23 per cent) of customers cashing in some or all of their pension will save it in a building society or bank account. The figure creeps higher – 26 per cent – for those taking all their pension pot as cash.
Aviva head of customer proposition for the consumer platform Anthony Rafferty says: “This is a big deal. I worry about people unnecessarily taking money from their pensions just because they can.
“Of course they are within their rights to and that’s what the Government wants to allow them to do, but I do worry there is a natural human behaviour that says if I can get access to money then I’ll take it.”
Royal London chief executive Phil Loney says: “It’s an emerging trend, it reflects that people think pensions are more restrictive and they are treating the reforms as a chance to get the money out while they can.
“We need to spend more time explaining to people if they’re taking their money out just to put it in a bank account or another non-tax advantaged vehicle, they need to think very carefully about that.”
The research suggests customers are ignoring the warnings providers are required to issue them when they access their savings.
And the problem is not just for small pots. Data compiled by James Hay shows 17 of its customers have fully encashed pots worth £250,000 or more.
The firm says those cashing in large pots included solicitors, actuaries and accountants.
Providers were handed with the new consumer protection rules, without consultation, at the end of February this year, barely a month before the introduction of the pension freedoms.
These stated providers have to personalise their communications based on individuals’ circumstances and knowledge.
They are required to ask questions based on how the customer wants to access their savings and give appropriate warnings, regardless of whether they have taken guidance or advice.
For instance, if a customer says they want to enter drawdown the provider must decide whether they understand issues such as tax implications, sustainability of income in retirement, charges, debt, the impact on means-tested benefits and scams.
However, providers say there is a limit to the level of detail that can be included in the warnings.
Scottish Widows head of pensions market development Ian Naismith says: “The defence was all put together quickly and focuses on the big picture issues and if you’ve got a short conversation with a customer you probably can’t get much further than that.
“However it does need to be fine tuned so people get a better understanding. Being over cautious is a real danger – people often plan to do something with the cash but never get round to it.”
Aegon regulatory strategy director Steven Cameron says providers need to do a better job of explaining what can be done within pension products.
He says: “A lot of the talk around the freedoms has been in the context of being free to get out of your pension, but equally you can have freedom while you’re still in your pension.
“Actually the reforms are about freeing up the system so you can use your pension to its greatest advantage.
“People think if it’s in their bank account they have ready access to it when they need it, where as they probably don’t think that’s the case within their pension.
“Investing in a bank account is hardly an investment strategy apart from that your money can’t go down in value in nominal terms. There are ways of doing that within in a pension, such as moving to a cash-based fund so there’s little chance of money going down.”
Money Marketing research shows providers are taking differing approaches to the rules. Hargreaves Lansdown is delivering the warnings on paper only, LV= uses paper, online and telephone support, while Phoenix Life only uses the phone.
The FCA is undertaking a review of the rules over the summer and Royal London is pushing to raise the prominence of the benefits of keep funds invested in a pension.
But Aviva’s Rafferty says the rules are strong enough. He says: “Around 60,000 people have used our tax planning tool, I think the consumer protection we deliver through the second line of defence is pretty strong.
“I don’t think it needs to be face-to-face, it’s fine to do it over the phone or on paper.”
There were a lot of things riding on the introduction of pension freedoms in April. As an industry we were optimistic that the extra flexibility and choice would make pensions more attractive and increase the number of people saving for their retirement. At the same time we very much hoped they would not lead to consumers spending their pension funds unwisely or too quickly.
Initial research by Royal London seems to show that some of these fears were unwarranted. The average size of the funds being withdrawn is relatively small and most of the 800 customers that we surveyed acknowledged that they were given information about taxation and warned about the effect on their future income.
On the other hand we also found that very few customers who had already made up their minds to take a lump sum actually altered their plans to withdraw money as a result of the risk warnings given, suggesting that we need to find a way to assist people with this decision early on in the retirement process.
The research showed that many customers had specific plans such as debt repayment or home improvements; however we also found that over a third of customers were simply planning to reinvest their money elsewhere. Of these, the majority intended to put their money in a bank or building society account, including cash Isas.
My main concern is that in order to reinvest their money the customer will incur a significant tax charge (most likely at the emergency rate of income tax), and at the same time the investments they are subsequently making are unlikely to offer anything that is not available within their pension. The tax charge may therefore be completely unnecessary, at least at that point in time. We definitely need to work harder as an industry to ensure that pension savers understand that once they reach age 55 pension funds may offer comparable access and control to a building society account, and considerably more investment choice.
At Royal London we will be looking to adapt the “second line of defence” questions for those who are planning to reinvest their money, and we will also be looking at improving customer engagement during the accumulation phase of retirement. These are steps that any pension provider could take, and we would urge the regulator and relevant industry bodies to continue to monitor consumer behaviour and adapt their guidelines to forestall actions that might leave consumers worse off in retirement.
The freedoms are a very positive thing for most people and we are supportive of consumer choice, however we would echo the pensions minister’s warning that people should not be in a hurry to take the money out of their pensions if they don’t have to.
Fiona Tait is pensions specialist at Royal London
Royal London customer research
- 69 per cent chose to take all of their pension pot as cash
- Average pot size being accessed was £15,500
- Average pot size being fully encashed was £14,100
- 32 per cent had contacted Pension Wise, 42 per cent had contacted an adviser, 56 per cent had contacted both. 42 per cent had done neither
Customer intentions for their lump sum
23 per cent save it in a building society/bank account
18 per cent plan to use on home improvements
16 per cent plan to use the funds to clear their mortgage/debt
10 per cent to have a holiday/several holidays
9 per cent invest in stocks and shares
7 per cent plan to replace their car/ cars
Source: 800 customers in May and July 2015 who have accessed the freedoms
Around 500,000 Royal London customers are eligible for the freedoms
Mel Kenny, chartered financial planner, Radcliffe & Newlands
If people have very small pensions and are earning a low to average wage then cashing in your pot, taking the tax-free money and putting the rest in a bank account isn’t too much of a problem. But for bigger pots above £30,000 the tax consequences and impact of inflation on cash need to be made absolutely crystal clear.