“Why employees need independent advice before deciding what to do with their pension freedoms”- REBA

This is the headline from a leader in REBA, the employee benefit magazine. I mention “employee benefits” with a grimace, for many benefits sold to staff through worksite marketing are not much more than the leverage of trust in the employer for the benefit of providers and senior management. The benefit is seen to be plugging a hole but the hole should not have been there in the first place.

Such is the case here. The second headline explains how little foundation in data is behind the first.

Despite initial fears of pensioners splurging cash on luxury goods, the bigger concern is that those who choose drawdown will still run out of money

As I’ve been reporting for some time, evidence from the FCA’s Retirement Income Survey tells us that where people take money out of their pension pot without advice, the three most likely actions are

1. Strip 25% (PCLS) and leave the rest alone
2. Cash the lot
3. Drawdown at 8% pa.

What the FCA data doesn’t show us , is what is happening to the millions of pots that are not being touched but which are simply rolling up. The evidence from Australia (and elsewhere) is that without a Retirement Income Covenant from the pension provider to help turn pot to income, most people draw too little rather than too much.

That’s why the Australian Government has introduced an obligation on providers, to help savers spend their savings. APRA (the Australian Regulator) has spotted the conflict between the commercial needs of Supers to hang on to money and the need for people to enjoy their retirement and recirculate money into the Australian economy.

So why do employees need financial advice?

If you were to consider non-advised behavior as trending to fecklessness, as you might if you saw 8% drawdowns as the normal, then IFAs might be needed to put the break on reckless spending leading to money run out. For me , a much better reason for independent financial advice is to create individual cash flow modelling which gives employees the confidence to spend their pots. But the cost of this modelling is high, it can only be achieved with a thorough knowledge of each employee’s total financial circumstances. So as an employee benefit, it sounds like that old fashioned phrase “executive counselling”.

The needs of senior staff for advice go far beyond cash flow modelling , they tend to focus on tax, especially the LTA, AA and MPA restrictions and often end up focussing on disputes between members and trustees , as in the recent case of Chalmers v Citibank where David Penney played an important role. (well reported in the FT on this link).

The cold reality of taking financial advice is in the cost/benefit analysis of the advice itself. The recent FCA paper on transfer redress suggested an initial take on cost for advice of between £1,000 and £3,000 with ongoing advisory costs of 0.5% pa. This assumes a pot of over £300,000, suggesting advisors are typically taking £1500 pa per client. That’s fine where the employee pot is £300,000 but the average pot analysed by the RCA’s Retirement Income Survey is £60,000, One fifth a BSPS CETV.

The harsh reality is that if you are an IFA and are offering an equivalent service to the £60,000 pot, you are either reducing your margin by 80% or you are have to charge a multiple of 0,5% (say 2.5%) or you are simply not doing the job with the same diligence. There may be a cut-price drawdown service but I know very few IFAs who are prepared to offer one, demand strips supply.

So financial advice for employees is an expensive business, and unlikely to be justified by a CMA unless the pot is large. Applying a charge greater than 1% pa for advising on a benefit amounting to not much more than 5% of the pot – risks reducing income by 20%. That’s a high price to pay for independent financial advice.

Simply applying a payroll deduction to fund financial advice (using adviser charging ) or negotiating a reduced fee , where the charge is levied on the fund, is unlikely to be seen as much of an employee benefit for all but senior staff.

And there are the added problems that most pots are not managed by providers prepared to see charges loaded into the AMC to pay advisers or to make deductions for the initial (tax advantaged) adviser charge. So most IFAs – with an abundance of wealthy clients in need of their services, will stay away from providing employee benefit (other than at full price). There is neither capacity or a gateway for this service, other than through certain contract based products offered through certain insurers.

Is there an alternative?

To consider an alternative , we need to go back and ask the question we are trying to resolve, partially present in the concern that

those who chose drawdown will still run out of money.

and properly considered by Australia as the need for people to spend the money they have saved in retirement so the money lasts as long as they do.

This , I hope , is where Adrian Boulding and the Royal Society of the Arts , are applying there thinking. For here there is a huge and growing societal problem. We have workplace saving but no pensions, instead a bodged job called drawdown which needs ongoing repair by IFAs to ensure it works, repairs that diminish the value of the product to a point where people will start questioning why they hadn’t simply been given a pension for their money.

Of course, the answer will come back , because since 2015 no one has had to buy an annuity with their pot. So can you have a limited freedom from the restrictions of annuities without the need for financial advice?

I would argue that you can, but you need to accept you are sacrificing some personal flexibility and taking some investment risk, to do so. The concept of a collective drawdown where the big problem of “not knowing when I die” is taken care of through mutual insurance, has not been popular in the UK for many decades. But it is the fundamental principle of UK funded pensions and is likely to reassert itself in time.

That’s because the individual drawdown model , requires independent financial advice and the cost and availability of that advice, makes such drawdown unviable as an employee benefit.

If this is pension freedom (I’m a banana).

Let’s suppose that the REBA headline was front page of the Sun, Mirror , Express or Star. Would people read “pension freedom” into a requirement for staff to get a lifetime dependency on financial advice as “freedom”.  I would expect to see comments rather ruder  than “if this is freedom, I’m a banana”.

We need a way to deliver people pensions from their savings , efficiently and without intrusion into people’s retirement. For most people, requiring a relationship with a financial adviser is inefficient and intrusive. It’s an imposition of intermediation which is devoutly to be avoided!