New Pension Rules Set to be Enforced in February 2021
The Financial Conduct Authority (FCA) is introducing ‘investment pathways’ to apply new rules and guidance on pension drawdown accounts.
The FCA is concerned that many unwitting consumers have entered into pension drawdown investments that may not give them the financial return and security they were perhaps hoping for as part of their financial future planning for retirement.
In the past, only consumers with larger pensions tended to use pension drawdown, but not before seeking professional financial advice. However, in recent years there has been a trend in consumers with much smaller pensions using pension drawdown, without taking any financial advice on investment options.
The FCA and financial experts are concerned that these smaller pension funds being held in cash investments in the long-term, will see inflation significantly dissipate the funds. As a result, investment pathways will be mandatory from 1st February 2021.
What is an investment pathway?
Following a Retirement Outcomes Review, the FCA decided to initiate investment pathways to provide protective advice and guidance to consumers who have entered into pension drawdowns, without seeking professional pension advice prior to doing so.
The investment pathways also provide guidance and new pension rules that pension providers and financial advisors must apply and adhere to, when providing pensions or giving financial advice to customers who are planning for retirement, respectively.
The Retirement Outcomes Review was conducted by the financial regulator as a vast proportion of consumers chose pension drawdown following the introduction of pension freedoms in 2015.
Pension freedoms gave consumers more options about how they used their pension money, that was not part of their 25% tax-free lump sum.
Before the introduction of pension freedoms, the 75% remainder of pension pots (i.e. the remainder after allowing for 25% as a tax-free lump sum) was historically used by most consumers to buy annuity products to pay a regular income until their death.
As a result of pension freedoms, consumers aged 55 or more can now access their pension pot and have the option to use the whole pension amount (100%) as a cash lump sum. And if pensioners choose to withdraw the full amount of their pension, they pay tax on 75% of their pension the same way as you have to pay income tax on a salary.
Note: Pension freedoms do not apply to ‘defined benefit pensions’ - these types of pension mean you are usually paid a set [defined] income when you retire, until your demise. These are also known as ‘final salary schemes’ as your pension income is usually based on your employed income when you retire.
The FCA’s new guidance and rules for all pension providers and advisors are:
- They should introduce investment pathways to any consumers who have entered into drawdown, without taking prior financial advice.
- They must ensure that any consumers who decide to enter into drawdown, only predominantly invest cash.
- Information must be sent out to consumers who chose to access their pensions, every year, detailing all “costs and charges paid over the previous year”.
How do pensions usually work?
A pension is a long-term savings and investment product that you (and/or your employer) pay into, to build up a secure, tax-free fund for your retirement.
Upon your retirement, you can opt to receive a regular income until your death (known as an annuity) or you can draw cash from your pension pot.
When you take out a personal pension, you usually decide on the age you would like to retire, what income you would like to receive on your retirement and then what percentage of your salary you need to pay until your retirement to achieve those financial results. Depending on your disposable income, you may need to retire later or receive less income on your retirement than you would otherwise like.
Usually, prior to the introduction of pension freedoms, an estimated 90% of people bought an annuity for their retirement so they would receive a regular income until their death. However, recent FCA data indicates that since pension freedoms were introduced in 2015, only 11% of consumers have bought an annuity, hence the FCA bringing in investment pathways.
Take a look at our guide on Saving for Retirement: Pensions and Alternatives for more detailed information on pensions and financial planning alternatives for your retirement. Alternatively, check out our related articles below for further guidance.