Tucked away at the bottom of page 54, was a paragraph in which the Financial Conduct Authority (FCA) raised concerns that ongoing charging models for advice, especially in retirement, “could lead to unsuitable choices”.
I believe, rather passionately, that this statement risks unfairly suggesting some financial advisers are not acting in the best interests of their clients – when the opposite is true. It also seems at odds with current regulations on investments. In a moment, I’ll explain why – but let’s first look at what the FCA said:
“There is a clear trend for advised consumers to choose drawdown more often than annuities, compared to non-advised consumers. We have concerns that advisers may be recommending products with an ongoing advice requirement, potentially instead of more suitable options that do not have ongoing fees.”
An incentive driving this trend could be related to the sale of IFA businesses, the regulator explained, because consolidator valuations of advice firms are based on recurring revenue streams.
Many in our industry felt the focus on a minority of bad apples was unfair but a simple fact was largely missing from this conversation.
The role of drawdown and ongoing advice
There is a slightly unsavoury implication in the FCA’s document that advisers are coercing customers into drawdown because they can get some kind of ongoing income stream.
But the reason many advisers are recommending drawdown in retirement advice – and, therefore, providing an ongoing service – is that it is often a simple case of drawdown being a better option than an annuity.
If, for example, a client goes through a standard Attitude To Risk (ATR) tool and emerges at the cautious end, then drawdown probably wouldn’t produce a better outcome. They would likely be recommended a fund that would be very low in equities and high in bonds and therefore it's unlikely to produce a better overall return than an annuity.
But if you have somebody that is average-to-bullish on an ATR, a decent proportion of equity content in a drawdown portfolio is far more likely to give a better return than an annuity and give them access to a transformationally different ability to be flexible and draw the money when they want to. And with state pension age rising there is an increasing demand for higher incomes in the early years where many want to retire before state pension age.
A second key point is that advisers generally deal with the larger pots, where the clients can often have a greater capacity for loss – and experience of investing – and so are more likely to be suitable for a product that isn’t risk free. In other words, not an annuity.
Finally, we need to think about what’s going to be happening to a retiree’s spending as they approach the end of their lives.
When you think about a standard annuity, you’ll build in inflation. And that makes sense year on year– but when you think about it over decades, the sense diminishes.
Imagine somebody who has a decent pension pot and they want to retire at 55 or 60 and will live to 90. They’re going to be spending more in the first decade of their retirement (think holidays, home improvements, new cars, doing all those ‘bucket list’ things etc.) than the last (where health and mobility will often ultimately restrict travel and expensive hobbies for example).
Clearly, an increasing annuity might not make sense in this situation – it might even lead to an accumulation of wealth – when drawdown allows the kind of sensible planning required.
A troubling inconsistency
Here’s where the FCA’s statement appears to fly in the face of current regulations. MiFID II has now made it a regulatory requirement that you have to provide an ongoing service in investments. Despite all the changes the directive brought in, bizarrely, it doesn't apply to pensions and much of the financial advice industry has been assuming that this anomaly would be tidied up at some point.
Okay, MiFID II didn't come from the FCA – it's an EU regulation – and, now in a post-Brexit world, it’s possible the UK Government will decide that they're not going to tidy this contradiction up. So, on one hand, we have regulations compelling us to provide ongoing advice for investments. On the other, we have an FCA document questioning whether advisers should be doing that very same thing in pensions.
Over all, there is something nanny-ish in the regulator’s statement as it suggests it could tighten up regulations because potentially some bad apples are giving bad advice.
Yet, pension freedoms were really helpful for most people – and as long as the vast majority avoid mistakes like encashing all their money without advice, then the latest “Sector View” on ongoing fees might not be particularly helpful.