Senior man sitting at table with laptop planning finances
Within the realm of pension schemes, a new approach called lifestyle pension funds has emerged. This strategy claims to take care of your retirement assets as you approach your golden years. While it may seem like an easy solution, it's important to understand that a lifestyle pension fund might not be suitable for everyone.
What is a Lifestyle Pension Strategy?
Lifestyle pension strategies aim to preserve the growth of your retirement savings as you near your designated retirement date. Initially, a larger portion of your pension is invested in equities, which offer higher potential for growth but come with more risk. As you approach retirement (typically 5-10 years before), your pension automatically transitions into lower-risk investments like cash and bonds. The objective is to have a retirement pot that is predominantly invested in cash and bonds, reducing exposure to stock market volatility when you begin drawing your retirement benefits.
Pension providers often refer to this approach as a "glide path." It's a way to protect individuals from the devastating effects of a sudden stock market crash just days before retirement. By gradually transitioning from high-risk assets to low-risk ones over several years, a lifestyle pension mitigates this risk.
Advantages and Disadvantages
In theory, lifestyle pension strategies offer certainty to individuals who are hesitant to make investment decisions within their pension funds. However, there are drawbacks to consider.
Times Have Changed
One of the ironies of lifestyle pensions is that they don't align with the lifestyles of today's retirees. Retirement needs have evolved over the years, with some people choosing to work longer or reduce hours before retirement. Additionally, lifestyle pensions were designed when it was compulsory for UK retirees to purchase an annuity. However, since annuities are no longer mandatory after 2015, income drawdown has become a more flexible and effective option for generating retirement income.
Inflexibility of Lifestyle Strategies
A significant factor to consider with lifestyle pensions is their rigidity. When you start a lifestyle pension, you are asked to specify your retirement date. The strategy focuses on growth assets during the early and middle years and gradually incorporates less volatile investments as retirement approaches. However, the timing of this transition from risky to less risky assets can significantly impact the size of your final pension pot.
For example, if your pension starts moving out of equities on your 45th birthday because you indicated that you plan to retire at 55, you could miss out on a decade or more of investment growth, limiting the overall value of your retirement savings.
Investment Strategy Considerations
While owners of lifestyle pensions have enjoyed strong investment returns in recent years, this can be attributed, in part, to the performance of bond markets. However, this may not continue in the coming years. The problem with a lifestyle pension is that it makes the transition based solely on the retirement date, without considering the prevailing investment market conditions. Sacrificing ten years of potential investment growth may not be the wisest decision when you want your retirement funds to last longer.
One Size Does Not Fit All
Lifestyle pensions became the default option for company pensions because they provided a straightforward plan: accumulate a pension pot and purchase an annuity upon retirement. Yet, without annuities as a requirement and with retirement dates becoming more flexible, the simplicity of the lifestyle approach becomes less viable. Considering the current economic climate and modern retirement patterns, there is a stronger case for keeping pension pots invested in growth assets well into retirement and utilizing income drawdown.
Have a Conversation About Your Pension
If you have a company pension invested in a lifestyle pension strategy, it is advisable to discuss the details with experienced financial planners who can assess whether it aligns with your retirement plans. Your retirement is a once-in-a-lifetime event, and an overly cautious or overly risky investment strategy can hinder your desired lifestyle. Let us help ensure that your lifestyle pension truly supports the retirement you envision.
Please note that this article is for informational purposes only and does not constitute investment advice or financial advice.
