The Retail Distribution Review (RDR), under the auspices of the Financial Services Authority (FSA), arrives at a decisive moment in the development of the UK pension system. We are experiencing a significant rise in the number of people enrolled in ‘defined contribution’ pension schemes, meaning that more people will be required to make investment and decumulation decisions for themselves. Essentially, the role of financial advice will become paramount within the pension system – just as one of the most significant transformations in the regulatory environment for financial advice gets underway.

To establish the quality and independence of financial advice, RDR changes will mean that financial advisers will have to charge clients directly for the provision of advice, rather than receive commission from product providers. While ostensibly laudable, the public appears reluctant to pay up-front fees for financial advice. The RDR also introduces new professional standards for financial advisers. The new regulatory regime will increase the cost of providing advice, which may mean that providing advice at affordable rates becomes prohibitive for many advisers.

This policy brief is concerned in particular with the implications of the RDR for people with small pension pots (SPPs). We know that people with SPPs are less likely to seek financial advice, therefore reducing the likelihood they will maximise their retirement income – if costs of advice increase, this trend is likely to intensify.

The first section outlines the background policy and economic issues to establish the context of the RDR’s impact on SPPs. It discusses the impact of population ageing and the high costs of living associated with increasing longevity, and the problem of undersaving and low pension scheme membership rates. It then details the growing incidence of SPPs, including information on the average size of pension pots, in the context of the rise of defined contribution pension schemes, before establishing the growing need for financial advice in the pensions system.

The second section considers in more detail the implications of the RDR for SPPs and financial advice:

• There appears to be a lack of willingness to pay for advice directly, which may lead to people eschewing financial advice after the RDR is implemented.
• This may have a particular impact on enhanced annuities, which may boost the retirement income for people in ill-health, of which around three-quarters are purchased following financial advice.
• There is already an advice gap for people with SPPs, who in fact make up the vast majority of annuity customers. All available evidence suggests this gap will widen following RDR, reducing the ability of people with SPPs to maximise their retirement income through the open market option.
• The number of financial advisers operating is expected to decline throughout 2012, and in fact has experienced significant decline. Introduction and summary 5 The Retail Distribution Review and small pension pots An ILC-UK policy brief
• Simplified processes, and a simplified product range, may benefit people with SPPs, but it is not clear whether either is a realistic possibility following the RDR.

The third section presents stakeholder views on the RDR and SPPs, as discussed at a summit in the House of Lords, hosted by Baroness Sally Greengross, in January 2012. The stakeholder meeting explored the following questions:

• What might the unintended consequences of the RDR be in terms of advice? • Will the RDR impact on people’s ability to shop around?
• How many independent advisers will stay in the profession following the RDR?
  What kind of risks are faced by people with small pension pots as a result of the RDR?
• Is there a role for simpler financial products, and generic advice?

The policy brief concludes that the RDR gives rise to a number of unintended – yet foreseeable – consequences that will impact upon the provision of advice to people with small pension pots. It makes a series of recommendations, including:

• the government and the FSA should investigate in more detail the opportunities to mitigate the implications of RDR for financial advice for people with small pension pots, and in particular people who could benefit from an enhanced annuity by shopping around;
• the government and the FSA should clarify the distinction between the provision of information and advice, and the extent to which providers are able to advise potential or existing customers without being deemed to give advice;
• the FSA restores a concern over the quantity of financial advice – as well as quality – to the heart of the RDR process;
• the government establishes mechanisms to ‘join up’ the public policy agendas on financial advice and enabling saving;
• the government continues to promote the open market option in the annuities market, and as such considers how to mitigate the potential impact of RDR changes on people’s ability to shop around for the best annuity deal; and
• the FSA publishes open market option take-up by wealth cohort – providing greater transparency about which people actually exercise their choice to shop around for the best annuity at retirement.