Is this the end for pension lifestyle funds?11 May 2016
Some of the UK’s largest pension providers; Scottish Widows, Standard Life and AEGON, have recently announced their intention to implement a mass transfer out for pension savers who are currently invested in lifestyle pension funds. This decision has been taken for the benefit of those who hold workplace or employer group pension schemes as, due to recent changes to pension legislation, coupled with the dramatic reduction in those buying an annuity at retirement, these funds are no longer fit for purpose.
This proposed change would represent a significant change to the way in which monies have traditionally been managed within group pension arrangements and, Gary Smith, Associate Director, Financial Planning at Tilney Bestinvest looks at the implications that such a mass transfer could have.
In this briefing, Smith looks at why lifestyle funds have typically been the default option of choice and why he welcomes the proactive stance that pension providers are taking to this issue.
What is a lifestyle fund?
A lifestyle fund or strategy simply reflects the manner in which a pension scheme provider will automatically move pension savers’ investments into lower risk funds as they approach their normal retirement age. The aim of life styling is therefore to try and ‘lock in’ stock market gains made during the initial growth period by gradually moving into fixed interest and cash funds.
How do these funds work?
These funds will typically initially invest the pension savers’ monies in a Balanced Managed fund or an Equity fund but, will then begin to automatically switch into fixed interest funds from either 10-years or 5-years (depends on which pension provider your pension is held with) from your selected retirement age. These switches will be done automatically, without the pension saver’s involvement, and will typically result in 75% of the pension being invested in fixed interest funds, with the remaining 25% held in a cash fund, in the final year before retirement.
This type of strategy was particularly popular for those who intended to purchase an annuity at retirement as, the 25% held in cash could be used to meet their tax-free cash entitlement, with the remaining 75% used to purchase an annuity, which is effectively funded by fixed interest assets; namely Gilts.
Are lifestyle funds without risk?
Although these strategies were designed to ‘lock in’ growth and protect savers from market volatility ahead of their retirement, investing in lifestyle funds is not without risk. Indeed, due to the automatic nature of how these funds are managed, monies will be sold from equity funds on set dates with no consideration given to the underlying market conditions at that time. Therefore, some savers could be significantly disadvantaged by this strategy as they could actually be ‘locking in’ a loss, with no potential to recover these losses once the assets are held in fixed interest. This would certainly have been the case during the ‘credit crunch’ where savers could have unfortunately found that losses of 30% or more would have been incurred.*
Whilst Fixed Interest funds are traditionally viewed as low risk assets, this is not always the case, especially during periods when interest rates are expected to rise or, where there is the real risk of default by the borrower on both the interest and maturity payments. After all, it is not that long ago that we faced the potential of Greece defaulting on its loans, and this resulted in a contagion effect within the fixed interest sector.
So why lifestyle funds are no longer fit for purpose?
The introduction of pension freedoms by the Chancellor effectively sounded the death knell for lifestyle funds, as an annuity purchase might no longer represent the retirement option of choice for many investors. Indeed, Scottish Widows have found that only 25% of their retiree customers had actually bought an annuity since the introduction of pension freedoms on 6th April 2015. They have been replaced either by flexi-access drawdown or by many retirees’ choosing to simply withdraw their entire fund as a lump sum, albeit subject to income tax.
Therefore, if you aren’t going to actually buy an annuity at retirement what is the advantage of using a lifestyle fund? After all, you will be giving up control over when to move out of higher risk funds and into lower risk funds, and if you choose to remain invested and draw an income from your portfolio continued exposure to equities and dividends could be vital.
Furthermore, if you are going to select a flexi-access drawdown arrangement in retirement, then your monies will remain invested and this removes the requirement to try and move into lower risk assets 10-years out from your intended retirement age. Indeed, there are far more efficient strategies that can be adopted, and you should discuss these with your financial planner.
What about default transfers?
Although lifestyle funds should be reviewed, we do have concerns surrounding the proposed mass transfer by pension providers into alternative funds. Our main concern surrounds the default fund into which the funds will be transferred into, as these might not necessarily accurately reflect the savers’ attitude to risk. I do have sympathy for pension providers as they are trying to make these changes for the benefit of their customers and I would encourage those affected to engage with their pension providers to fully understand the options that are available to them.
To discuss this or any other financial planning topic please contact Gary Smith on 0191 269 9971 / firstname.lastname@example.org
*Between the period April 2007 to March 2009 the FTSE 100 fell by 32.67%
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The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This press release is not advice to invest or to use our services. If you are in doubt as to the suitability of an investment please contact one of our advisers.
Before accessing your pension it is important to consider all of your options therefore you should seek professional financial advice or visit Pensionwise.gov.uk.
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