This model for pensions may no longer suit
.jpeg)
I confess, as we get closer to Christmas I’m feeling uncharacteristically Grinch-like and bah-humbug in some respects.
Recently, I’ve seen more examples of how pension “lifestyle” funds are in fact distinctly unstylish –ill-fitting and outdated in the current environment.
If you don’t know what “lifestyling” is, it’s a technical term in pensions.
And it’s one everyone with a workplace or private pension should understand. Essentially it refers to the “de-risking” of a portfolio as an individual approaches retirement.
The process typically starts in the five to ten years before a selected retirement age, when a portfolio is gradually shifted away from equities –shares in listed businesses –towards traditionally lower-risk assets, such as bonds or cash, in order to shield from market volatility.
Lifestyling was designed to help individuals prepare to purchase an annuity when this was a common, or even compulsory, use for pension savings.
Times have changed, and lifestyling may no longer be the best option for individuals, depending on their circumstances.In the 2010s, purchasing an annuity became a less popular option with clients. When the great pension freedoms shake-up came in 2015, people were no longer compelled to buy. Low interest rates and low gilt yields kept the annuity rate –the percentage received annually as income –down, too.
Instead, drawdown from pensions became the preferred option for retirement income, with people taking either regular payments or lump sums. It makes sense mathematically and offers more flexibility. It became possible to get a higher income and preserve access to your capital. Keeping your pension pot going gives greater flexibility in making provision for others. Provision for spouses or dependents can only be made at the point of purchasing an annuity, whereas expressions of wish for pensions can be updated if circumstances change.
So we have seen a change in the term for which an individual invests over a lifetime – where previously you invested until retirement age (usually in your 60s), now you might be investing for life, even up to the age of 100. Entering a five-to-ten-year lifestyling phase before retirement fails to account for this longevity of investment horizon.
Given that later earning years may also be those in which you might be able to make higher pension payments – after expenses such as houses and children have been paid off – you may miss out on maximising the potential of these larger contributions to a diversified portfolio.
But lifestyle funds have brought adverse outcomes in recent years. The 2020s have brought disruption through an inflationary environment, higher interest rates, and consequent changes in the bond market.
It’s true that when annuity rates rose alongside interest rates after the Kwarteng mini-Budget, some were quick to cash in. However, increasing interest ratesand inflation are the key risks to gilt and fixed-interest prices and so, topped off by the “fiscal event”, prices crashed.
The value of pensions heavily invested in these “low risk” assets tumbled. We saw new clients walking in with six-figure declines in portfolios they intended to begin drawing on. Had they not been “lifestyled” out of equities and remained in diversified funds the loss would have been much less severe – if any at all – over the same period.
Lifestyling is often the default option in many defined contribution workplace pension schemes. If you are not aware of where you stand, and especially if you are within ten years of retirement, this is something to check with your provider. You should be notified before it begins and you should have the option to opt out, but actively checking puts the power in your hands.
The intent to bring pension pots into the scope of IHT from 2027 signals the government’s ambition to steer pensions towards being funds for life rather than for legacy. This may change the mix of how pension income is typically made up, moving towards a hybrid model.
Annuity purchases may continue to rise. Individuals may choose a fixed income to cover essentials and draw from their invested funds for discretionary or emergency spending.
As with everything it is essential to understand what you are invested in and what the risks as well as the opportunities are. To me, lifestyle funds create more of a risk to most people’s future lifestyle than they stand the chance to enhance it.My tidings of comfort and joy? There are other options available – take action and take advice.
Find out more here