As the two-pot retirement system comes into effect, clients’ investment strategies could be impacted. It’s important for clients to understand the need for leading with a financial plan, rather than just being influenced by the system.
As the two-pot retirement system becomes a reality, financial advisers must consider how this change impacts their clients’ investment strategies. While the system aims to offer greater flexibility for individuals facing financial hardships, the focus should remain on maintaining a sound investment strategy that aligns with long-term retirement goals.
Understanding the two-pot retirement system
Starting 1 September 2024, new retirement contributions will be divided into two distinct pots:
Retirement pot: Two-thirds of contributions will go into this pot, which remains inaccessible until retirement.
Savings pot: The remaining one-third will be allocated to this pot, allowing members to make one withdrawal per tax year.
Additionally, all accumulated retirement savings up to the implementation date, minus any amounts transferred to seed the savings pot, will be classified as the vested pot, which will continue to be governed by existing rules.
Investment strategy considerations
Vested pot: For most clients, the vested pot will continue to function under existing investment strategies. If a client’s current strategy meets their needs, there is no immediate reason to adjust it.
Retirement pot: The retirement pot is designed for long-term growth and clients cannot access these funds until they retire. While there may be a temptation to shift towards less liquid asset classes due to the lack of immediate access, advisers should carefully assess whether such a move aligns with the client’s overall financial plan. The original asset allocation would have been selected based on expectations of remaining invested until retirement. Therefore, any changes should be justified by a revised financial plan rather than simply the new system. Clients can still transfer their retirement pot assets to a different provider if they change jobs or if a new investment strategy is more appropriate. Advisers should continue to monitor and review these strategies to ensure they remain aligned with the client’s long-term goals.
Savings pot: The savings pot introduces a new dimension to retirement planning. Given the option for annual withdrawals, the investment strategy for this pot requires careful consideration. While the primary goal of retirement savings remains unchanged, advisers must balance the need for liquidity with the potential for long-term growth.
In an ideal scenario, clients would preserve their savings pot until retirement. However, the reality is that many households face financial challenges that may necessitate accessing these funds. For example, a middle-income earner with multiple financial obligations may struggle to manage unexpected expenses without dipping into their savings pot.
Given the potential need for liquidity, the investment strategy for the savings pot may differ from that of the retirement pot. More liquid, conservative, and moderate portfolios can offer short-term capital protection, which could be crucial for clients who anticipate needing to access their savings pot regularly. However, an overly conservative approach could also limit the growth potential, leading to lower fund credits at retirement.
Practical implications for advisers
Investment profiles for the savings pot: Depending on the frequency of withdrawals, clients may benefit from different investment profiles…
Short-term savings: For clients likely to withdraw from the savings pot every tax year, consider recommending money market assets that prioritise liquidity and capital preservation.
Medium-term savings: For clients planning withdrawals every three to five years, a mix of equities, property, and fixed income assets could be appropriate, with a target return of CPI + 3%.
Long-term savings: Clients who expect to make only occasional withdrawals (no more than two or three times during their working life) may benefit from growth assets targeting CPI + 5%.
Key considerations
Opportunity cost: Advisers should caution clients against automatically adopting a conservative approach for the savings pot. The opportunity cost of forgoing long-term compounding can be significant, especially if the client ends up not needing to access the funds regularly.
Underlying asset manager analysis: Frequent withdrawals could impact Market Value Adjustors (MVAs) on guaranteed portfolios. Advisers should carefully assess whether smooth bonus strategies are appropriate for the savings pot, as they are better suited to the vested and retirement pots.
Preparedness of administration systems: The ability to implement different investment strategies for each pot depends on the readiness of fund administrators. Advisers should ensure that the systems in place can accommodate these strategies before making any recommendations.
Guiding clients through the two-pot transition
The two-pot system presents both opportunities and challenges for financial advisers. By carefully considering the investment strategy for each pot, advisers can help clients navigate this new landscape while maintaining focus on the ultimate goal: achieving the best possible outcome at retirement. It is essential for clients to discuss their specific needs and goals with their adviser before making any changes to their investment strategy. This approach not only helps clients make informed decisions but also allows advisers to strengthen engagement and continue enhancing their clients’ financial well-being.
