The FCA has warned advisers not to rely on cashflow modelling without stopping to consider whether it is accurate or not.
As part of its retirement income thematic review, the regulator found instances of advisers not challenging clients on figures provided.
For example there were instances where income and expenditure indicated savings were available, but the client had no savings and there were instances of advisers not thinking about future lump sum needs such as replacing cars or carrying out home maintenance.
The FCA said cashflow modelling can provide a reasonable basis for giving advice, but only if the firm uses complete, accurate and up-to-date information.
The regulator said: "A firm is entitled to rely on information provided by clients unless it knows the information is clearly out of date, inaccurate or incomplete.
"We would expect firms to consider if the information clients give them is consistent with their stated goals or expectations for retirement. This information is key to providing suitable advice."
The FCA also warned advisers about failing to draw their own conclusions on whether a cashflow model's outputs were suitable.
It found instances of firms failing to identify where the cashflow model had relied on illiquid assets, such as the client’s main residence or non-rental property, for lifestyle expenditure, and of firms failing to realise the model relied on pensions being accessed before the minimum pension age.
Among the things the FCA said firms should check were:
- they have a reasonable basis for the estimated expenditure in the cashflow modelling, both at present and in future, taking into account the client’s needs for the basic cost of living, desired lifestyle expenditure, discretionary expenditure and savings
- how the client’s personal circumstances and lifestyle are likely to change throughout retirement and how this might affect future expenditure
- they are using up-to-date salary information to calculate current net income and identify surplus/deficits in current household budgets
- they can justify any estimated figures used in the projection
- how the cashflow modelling software handles cases where expenditure is expected to increase in some years, for example for university funding or to meet specific expenses like mortgage repayment
- how the model handles potential tax liabilities
- the stress testing scenarios and what they would mean for the client’s income in retirement against their expenditure needs
The FCA said it also found instances of firms using unjustifiable rates of return as part of cashflow modelling, for example high returns were assumed for cautious assets with no explanation and projections based entirely on past performance.
It said: "A client’s investment objective may rely on their investments achieving a certain rate of return. So, if the firm’s modelling is based on incorrect assumptions, there is a higher risk of poor consumer outcomes.
"The client is not likely to understand the risk that they will not achieve the returns they need to achieve their objective and so will not be in an informed position."
The regulator said advisers should undertake regular reviews of the assumptions they use, taking into account wider economic circumstances and should be careful about presuming their ability to predict variable future rates of return to avoid the impression of accuracy.
There were also instances of advice firms not explaining to their clients that cashflow modelling is based on assumptions which can give an undue impression of certainty.
The FCA said that if a client understood returns were based on assumptions about how the market would perform (and their investment value may go up or down) they were less likely to withdraw more than they could afford from their pension or investments.
For example advisers should not only plan for average life expectancy, when 50 per cent of people will live longer than this.
