Savers to be offered four simple ways to invest and draw pension pots

26 mins read


Savers will soon be offered four ready-made investment deals when they first dip into their pension pots, if they are doing this without paying for financial advice first.

They are designed to help those who want to keep their pension invested in retirement by delivering returns and avoiding common mistakes, such as taking too much risk or sticking with measly rates on cash. 

Pension firms are tailoring new simple, pre-packaged funds to the most common goals of over-55s, who often want to take their 25 per cent tax-free lump sum but leave the rest of their savings alone for at least the next few years.

Regulators have ordered providers to make the new offers, which will be launched on 1 February, out of concern inexperienced investors are making poor decisions.

Investment plan: Many are unprepared for complicated set of decisions they must make when living off their investments during retirement

Investment plan: Many are unprepared for complicated set of decisions they must make when living off their investments during retirement

Typical blunders are sticking money in cash funds where they get eaten up by inflation and charges, or taking unwise risks in the stock market.

The hope is that making basic deals easily available will help people use popular pension freedoms, which give them greater control over their retirement savings, more successfully – though they are not compulsory.

Around 90 per cent of workers build up their pensions in their employer’s ‘default’ funds, in which their savings are placed unless they actively choose otherwise.

Many are therefore unprepared for the more complicated set of decisions they must make when living off their investments during retirement, but reluctant to pay for financial advice on crucial issues like how much income to take so they don’t run out of money.

We look at how the four new investment options will work, what kind of financial assets they will hold and the likely charges below.

What are the new options for investing in retirement?

Pension firms must offer people who enter a drawdown scheme four investment ‘pathways’, designed to meet their broad needs, but there is no obligation to choose any of them.

What is pension freedom? 

Pension freedom reforms gave over-55s greater power over how they spend, save or invest their retirement pots.

Key changes from April 2015 included removing the need to buy an annuity to provide income until you die, giving access to invest-and-drawdown schemes previously restricted to wealthier savers, and the axing of a 55 per cent ‘death tax’ on pension pots left invested.

The changes apply to people with ‘defined contribution’ or ‘money purchase’ pension schemes, which take contributions from both employer and employee and invest them to provide a pot of money at retirement.

They don’t apply to those with more generous gold-plated final salary or ‘defined benefit’ pensions which provide a guaranteed income after retirement.

However, those still saving into such schemes can transfer to DC schemes, provided they get financial advice if their pot is worth £30,000-plus.

The basic scenarios these deals are designed to cover are:

1. I have no plans to touch my money in the next five years

2. I plan to use my money to set up a guaranteed income annuity within the next five years

3. I plan to start taking my money as income within the next five years

4. I plan to take out all my money within the next five years.

But this is very broad and pension experts point out that people will still be left to make many other important decisions.

Some need to be reviewed regularly, and others taken when either your personal situation changes or financial markets are in one of their fairly frequent bouts of upheaval.

Issues not covered by the pathways which you should consider include:

– Should you take some or all of your 25 per cent tax free lump sum – read more here 

– How much income to take, and whether this needs to change over time

– Whether your fund will run out before you die, on an unknowable date

– Your appetite for investment risk

– How to minimise your tax bill

– What you will do if markets crash – read more here.  

What will you be putting your money into?

A couple of DIY online brokers have previewed what funds they will be using for each ‘pathway’ and why they think they are suitable.

Providers’ deals will vary, but these are useful examples which include charges, and offer an insight into the reasons why certain assets will fit the profile of the investors self-selecting themselves into the four options.

Interactive Investor 

1. I have no plans to touch my money in the next five years

Vanguard LifeStrategy 60% Equity (Charge: 0.22 per cent)

How to invest your pension and live off it in retirement 

Read our 12-step starters’ guide, and find out the opportunities and the pitfalls to avoid. 

II says this is a low-cost fund with a mix of equities and bonds that provides potential for growth and maintains the same level of equity allocation – and the same risk profile – in the fund over time.

‘Vanguard are already a very popular option with our customers and many are already invested in the LifeStrategy range, making it an obvious follow on fund for customers who are not looking to touch their money for the next five years.

‘From a suitability point of view, the fund meets all the requirements of the pathway objective and its long-term performance is exceptional.

‘It is also likely to be owned by customers who are looking for a one-stop shop and therefore there is huge consistency and awareness of the fund that is likely to be of benefit to customers.’

2. I plan to use my money to set up a guaranteed income annuity within the next five years

iShares Core UK Gilts ETF (Charge: 0.07 per cent)

II says it chose a government bond fund to match the type of assets that insurers use to fund the annuity payments they make to their customers. This would commonly be considered a low risk option.

It considered using a fund which included corporate bonds, in addition to government bonds, but says: ‘Bearing in mind a recessionary environment, gilts are a more risk-averse option. An index-tracking GBP currency-based bond fund is appropriate.’

II adds that the advantages of an index-based fund are that it is diversified, transparent, liquid, low-cost and has targeted exposure, and that it believes this fund is ‘excellent value for money’.

Free investing guides

3. I plan to start taking my money as income within the next five years

Vanguard Target Retirement 20 (Charge: 0.24 per cent)

‘The mandate of the fund is specifically to reduce risk over time, which is suitable for this self-selecting cohort of investors who are looking to start taking an income from their portfolio over the next five years,’ says II.

‘While this targeted retirement fund may be a new concept for investors, the trusted name will make it easier for an investor to consider.

‘The long-term performance of the fund is good, though a comparison is difficult bearing in mind the lack of competitors.

‘The risk of set-and-forget investors is minimised with a glide path strategy.’

4. I plan to take out all my money within the next five years

Royal London Money Market fund (Charge: 0.10 per cent)

II says that more than 75 per cent of its investors who have taken all the money out of their Sipp (self-invested personal pension) have done so within the first year, so it believes a cash fund is an appropriate option for people choosing this pathway.

It’s worth noting that money market cash funds are controversial, they involve investors paying to hold cash rather than being paid interest as they would in a bank account. With a Sipp, there may be specific tax reasons for doing this though. 

‘The mandate of the fund is to deliver capital preservation net of fees, which is the only appropriate mandate for a group of customers who may take all their money within 12 months.

‘A money market fund is likely to be easily understood and relevant for this cohort of customers. If the time horizon of our investors had been longer, then we would have chosen a gilt fund.

‘There is a risk of set-and-forget investors being in “cash” if they remain in this pathway for five years, let alone 10-15 years. However, customers will receive updates from II during the period.

‘Investors choosing this pathway are making a conscious choice and it will be clearly communicated that this is not a good long-term solution.’

AJ Bell Youinvest

AJ Bell has gone down the route of recommending its in-house funds.

1. I have no plans to touch my money in the next five years

VT AJ Bell Balanced fund (Charge: 0.34 per cent)

The objective of this fund is to achieve long-term capital growth with a balanced approach between ‘defensive’ assets, says AJ Bell.

These include cash, fixed interest securities, money-market funds and collective investment schemes following alternative strategies such as property and commodities, and higher risk assets such as equities.

2. I plan to use my money to set up a guaranteed income annuity within the next five years

VT AJ Bell Cautious fund (Charge: 0.35 per cent)

This fund aims to achieve long-term capital growth with a high level of exposure (often indirect) to defensive assets such as the ones above, plus a low level of exposure to higher risk assets such as equities, says AJ Bell.

3. I plan to start taking my money as income within the next five years

VT AJ Bell Income fund (Charge: 0.74 per cent)

The goal of this fund is to generate an income, whilst maintaining capital value over a typical investment cycle, says the firm.

‘It has a target average yield of 3-5 per cent per annum (over a trailing three year period), which is not guaranteed. This is consistent with a goal of capital preservation and drawdown of an income.’

4. I plan to take out all my money within the next five years.

VT AJ Bell Cautious fund (Charge: 0.35 per cent)

As above.

What about charges?

Investment fees will vary as shown in the examples above, and there will be investment platform or admin charges to consider as well. 

But the Financial Conduct Authority has refrained from imposing a charges cap on the ‘pathway’ products, at least for now.

However, it has told firms to challenge themselves on the level of charges for investment pathways, using the 0.75 per cent cap on default arrangements as reference.

The rules are intended to reflect that charges are only part of the picture, and that the FCA is keen to ensure the pathways represent ‘value for money’. That can be taken to mean it’s interested in decent investment performance as well as cost.

The FCA plans to review the rules a year after their introduction on 1 February, and this will include another look at charges. 

What are the other options?

You can swerve the four ‘pathways’ and pick an alternative but more sophisticated pre-packaged investment plan from a pension drawdown provider.

Or, you can choose the investments you prefer to put in your drawdown plan from scratch yourself.

You can also put off going into investment drawdown, if you don’t actually need any cash right away.

Savers often feel pressure to use pension freedoms after age 55, when the best course of action is often to do nothing with their retirement pot.

If you are unsure, here are 10 questions to ask yourself before acting, with the list topped by: ‘Do I really need to take any of my pension money now?’ 

It’s also worth noting that financial experts advise spending your pension pot last, after your other savings, to protect your money from the taxman. 

You might also reconsider paying for financial advice.

Should you get financial advice before entering pension drawdown?

When you invest a pension and intend to live off the income over many decades, an adviser can help you sort through all the important issues listed earlier like how much income to take and how to keep your tax bill down.

My adviser charges nearly £3k a year to help invest a pension worth £200k 

Is that a fair price? An expert replies here.  

You can get one-off advice at the start, although most advisers will probably try to persuade you into an ongoing arrangement that involves paying annual percentage fees.

We looked into the pros and cons of these two approaches, and what you should weigh up before deciding how much help you need investing your pension here. 

Justin Modray, director of Candid Financial Advice, warned at the time that some advisers will ‘harvest’ pension investment business by putting clients in their own in-house funds and on their own platforms, and then get a cut from the fees they generate as well as for ongoing advice.

‘There are two big risks to this – high fees, and if you don’t like the adviser and you are in in-house funds on a personal platform, you are tied to that,’ he said.

Modray said to avoid this, people should take one-off or ongoing advice from a firm that is willing to use an investing platform that’s available across the market, direct to consumers and to other advisers.

That way, if you decide you don’t like your adviser, or simply want to look after your investments yourself, you won’t be tied to your original firm and their platform. 

Making your investments portable, and accessible by other advisers, means you won’t be limiting your future choices.

Going it alone: You can choose the investments you prefer to put in your drawdown plan from scratch yourself

Going it alone: You can choose the investments you prefer to put in your drawdown plan from scratch yourself

Meanwhile, another halfway house option between one-off and ongoing advice could be to pay an adviser to set up a portfolio you are comfortable monitoring and managing yourself at the outset of retirement, and then get your investments and financial circumstances reviewed at intervals.

You could aim to do this every five years, or when there is a significant development like receiving an inheritance – and perhaps use a new adviser each time, which would have the advantage of getting fresh eyes on your finances.

If you are considering paying for ongoing help over many years, question an adviser closely about what services they will offer that could make this worth your while, and listen with an open mind.

Rules and taxes change over the years, and input from an adviser can keep you on the right track and help you avoid costly mistakes. 

If you want free guidance on your options, you can book an appointment with Pension Wise here, and the contact details of the Government-backed Pensions Advisory Service are here. 

What do pension experts say?

‘Some individuals approaching retirement who don’t want to buy an annuity and have decided on drawdown instead may never have made investment decisions of their own,’ says Steven Cameron, pensions director at Aegon.

Some iwho don’t want to buy an annuity and have decided on drawdown may never have made investment decisions of their own 

‘Under automatic enrolment, most employees in workplace pensions make no active investment choice and instead are invested in a default fund.

‘The regulator is concerned that some individuals who don’t take advice could then make particularly unwise investment choices, for example taking on too much or too little investment risk.

‘What’s right for one person may be much less so for another depending on how much income an individual plans to take when, or if they are planning to buy an annuity at a later date.

‘The idea behind investment pathways linked to retirement scenarios, supported by guidance offered by pension providers, is to help reduce the number of individuals who make particularly inappropriate investment choices.’

But Cameron cautions: ‘While investment pathways will offer some help to those who choose to “go it alone”, it’s really important to understand that they won’t replace the benefits of taking professional financial advice.

STEVE WEBB ANSWERS YOUR PENSION QUESTIONS

       

‘There, an adviser will examine each individual’s personal circumstances and make a personalised recommendation on where to invest as well as how much income can safely be taken to last throughout life or meet other retirement objectives.

‘Advisers can also review the best approach on an ongoing basis, reflecting changes in investment conditions or personal circumstances.’

Tom Selby, senior analyst at AJ Bell, says of the new pathways: ‘This change, instigated by the FCA, is significant and it is vital savers understand the new options available to them.

‘One of the central aims of pathways is to reduce the number of customers holding cash or cash-like investments for the long term and seeing the value of their money whittled away by inflation.

‘They also aim to ensure people engage with their investments when going into drawdown so they remain appropriate to their needs.

‘While these are laudable goals, those who are nudged towards the regulator’s pathways need to appreciate that this isn’t advice based on their personal circumstances and that the responsibility for their investment decisions still rests with the individual.

‘Pathways merely offer very broad investment options based on four basic outcomes. As such, they do not take into account someone’s appetite for risk or withdrawal strategy in any detail and must not be seen by as a replacement for engagement or seeking regulated financial advice.

‘Investors still need to check that the risk level and objective of the fund is aligned with their needs and that they are comfortable with the charges they are paying in return for the service being offered.

‘All investors – whether they are invested in pathways or have chosen their own investments – need to regularly review their investments to ensure they are delivering against their objectives and remain appropriate for their evolving personal circumstances.’

Jon Greer, head of retirement policy at Quilter, says: ‘Taking money from your pension is a very important point in a financial journey, and not a simple one.

‘This is money that has been built up over a lifetime of saving with the aim of having a comfortable later life and retirement.

‘People often spend significant time building up the funds but a lack of education means they don’t realise the importance of how they take the money and what happens to their pension pot once they do.

‘Investment pathways are a critical step to ensure those that start withdrawing from their pension are properly invested.

‘However, while this is a nice crutch it is no fix for proper engagement and planning for drawdown. It is absolutely vital that people create a proper retirement plan and seek financial advice so they can enjoy the retirement they worked so hard for.’

TOP SIPPS FOR DIY PENSION INVESTORS

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