Retirement guidance: who to trust
Is the bloke in the pub trusted on financial matters (family and friends regularly poll highly in consumer research on who to turn to) because he is impartial or because he’s thought to be street wise, good with numbers and in touch with real life? I know what I think. And if I were writing a computer programme to make good financial decisions, I would rely more heavily on the game-player attributes of the ideal bloke in the pub, which combine understanding of the rules of the game with insight into how to win the game, than I would on the way decisions appear currently to be taken by professionals. But right at the bottom of the list of inspirations for my decision model would be the do-gooders that have responsibility for making public policy in this area. This is wholly relevant to the current topic of the ‘guidance guarantee’.
The ‘guidance guarantee’
The Chancellor’s big idea to accompany the Budget retirement income freedoms with a guaranteed right of access to free impartial guidance is now taking shape.
The DWP has decided that the industry will not be trusted as an impartial source of advice, having too much interest in selling particular products or services, hence the need for non-commercial organisations such as two existing statutory bodies, The Pensions Advisory Service (TPAS) and the Money Advice Service (MAS). The power to appoint the pension guidance providers lies with the Treasury but the FCA will lay down the principles and be responsible for regulating the agencies’ practices. It is currently consulting on the principles and the rule changes necessary to put them into practice as well as changes in the rules for existing advisers that allow for the fact that retirement products no longer have to provide an income to last a lifetime.
Someone needs to ask the question: impartial though these public bodies may appear, are they in fact a likely source of sensible guidance or is officialdom systematically biased in its view of what makes for good counsel in matters of finance?
The Chancellor’s new freedoms seem inspired by an instinctive disliking of the nanny state but whether the nanny state effectively lives on depends on the messages the guidance delivery agencies choose to deliver. Enough of the political jargon: let’s call then guides. But let’s not call them advisers, because they are not allowed to make recommendations, only educate people to make sensible decisions and possibly refer them on to the kind of commercial organisations who can give advice or can sell specific products.
Scope of the guarantee
Before leaping to judgement about whether statutory bodies can provide good guidance on individual decision making, we ought to consider the scope of the guidance service the DWP has decided on. It is much broader than it could have been and in particular involves collecting a lot of personal information (assuming it is willingly divulged) to make the guidance more appropriate in each case. This is fundamentally different from a generic and universally-applicable explanation of the different options a retiring person has for converting pension capital to an income stream. It requires judgement about the relevance of the personal information (both financial details describing the context and the ‘needs and wants’ that describe the objectives). This looks a lot like the holistic scope of a professional financial adviser operating under the full rigour of the FCA’s suitability rules. With professional training and practice comes (we might assume) the judgement I referred to.
Incidentally, the enlarged scope surely now calls for a reassessment of the ‘official’ estimate of the cost of providing the guidance, which at £35 always looked too ambitious, even with a presumption of a high proportion of online delivery. However, the guidance project has always invited technical innovation – including, perhaps, the sort of decision-support programmes that I alluded to in the introduction. This is necessary not only to keep the costs down but also to ensure the consistency of good standards of guidance. Except they will be devised by do-gooders who don’t rate the decision-making skills in the pub and think those blokes are part of the problem, not the solution.
To illustrate the point, we need only consider some of the aspects of game theory relevant to good decisions about retirement options.
For many households with low income and small retirement pots, it is likely that the key is to understand the interaction of income and benefits. In fact, this was explicitly recognised by the Chancellor in his Budget speech when he related the decision to scrap any requirement to make a pension last a lifetime to the Government’s earlier enhancement of the state pension. But income in retirement is also a factor affecting entitlement to both housing and residential care. So courses of action that maximise individual utility are not necessary compatible with the wider public interest. Do you want your guidance street-wise or socially-cleansed?
At the bottom end, approved guidance is likely to suffer from a bias (evident in both framing of the guidance and its outputs) to supposed low-risk options. Public policy has to quite grasped the enormity of the insight that people cannot afford to avoid risk in the way that, for example, the FCA and the Financial Ombudsman Service both demonstrate as a presumption. I suspect the Chancellor understands this but that’s not the point.
For households with more income and perhaps more than one pension ‘pot’ (whether personal-pension products or entitlements arising from different employer schemes), it is likely that the key is to understand tax effects. As we pointed out in an article immediately after the Budget, the implication of pensions not having to provide an income for life is that that function passes to the entirety of someone’s resources, including (potentially) the money tied up in their home as well as financial assets not held in a pension ‘wrapper’. The holistic approach to maximising household utility in retirement was already the right one at the high end of the advice market but in calling our article ‘democratising drawdown’ we were making the point that the same principles were being extended to the mass market.
Utility is clearly defined in after-tax terms, not pre-tax, because spending is. The FCA has had to recognise this important implication in its proposed changes to the rule book and has written tax into the scope guidance providers must cover.
An optimal strategy for the rate at which pension pots are withdrawn is a tax strategy, not a spending or insurance strategy, as these other attributes of utility (e.g. maximising real spending subject to not running our or having to alter spending drastically) can be met by other vehicles, such as ISAs or even taxable investments, into which pension savings are tipped. Viewed as a tax strategy, the rate at which the pension pot is drawn is determined by marginal tax rates and availability of alternative wrapper capacity and by the treatment of death benefits in a pension fund (as long as this remains subject to different rules). Is this the kind of personally-appropriate guidance that a statutory body is likely to be able to provide effectively or does it also conflict with the greater good of society as a whole? Do we know any other government-sponsored organisations that exist to help people minimise tax?
Both my examples require the application of maths as well as logic. It is not entirely frivolous to wonder whether either skill is fundamental within social organisations in the way that they both are in the advice business. As we often find ourselves writing about, the maths of pensions are not even grasped within the DWP itself, otherwise we would see many different reforms being discussed.
Whatever the role the statutory agencies play and however well they play it, we can anticipate that the commercial sector will itself employ maths-based logic embedded in computer programmes to aid decision making. In fact, they are likely to have been used well before retirement, to support choices about managing the conflicting claims on savings at different life stages, not just retirement. They could have been the main basis for determining risk preferences and trade offs that individuals made for themselves. So the sources of retirement income are likely to have been addressed years before the guidance guarantee kicks in.
The challenge, then, is to make these commercial services believable as impartial sources of guided decision making. As we have seen, the direction of travel is not in one direction only. It is much easier for commercial providers to demonstrate that, wherever there is any conflict between individual advantage and society as a whole, they take the individual’s side. They are more likely to be seen as street-wise, however hard organisations like MAS work on their voice.
The main challenge for commercial services in establishing credibility is relative to product providers. The decision process needs to be seen as leading anywhere it should, because everywhere it could is equally free of any vested interest. That can be evident from the experience of interaction with it (something that is hard to fake). But it is also signalled by the method of charging: impartial advice requires a subscription or fee-for-service model if it is not to be contingent on the particular destination.
Criticising the guides
This might be the last time I cast doubt on the providers of the guidance guarantee. Once they are up and running I risk a breach of the FCA’s rule book, as one of the proposed rule changes reads as follows:
“An example of behaviour that is likely to contravene the client’s best interests rule or Principle 6 and may contravene other Principles is for a firm to actively discourage a retail client from using the guidance service referred to in COBS 19.4.1R(3)(d), including by: (1) holding itself out as providing, or referring the client to another person who holds itself out as providing, an equivalent service; (2) leading the client to believe that using the guidance service is unnecessary or would not be beneficial.”
Fair enough – as long as the FCA is open to criticism of the maths and logic employed by the guidance providers. That’s a lot to hope for, not just because they are by nature protective of their own kind but also because their mandate from the Treasury runs only to laying down the principles the guidance agencies have to follow, not the detail. The guides will apparently be beyond criticism by the likes of us professionals. Nanny is guaranteed the last laugh.