What is pension lifestyling and should you be using it?

What is pension lifestyling?

Lifestyle or target retirement funds focus on assets to maximise growth, mostly shares, in the early and middle years of your working life. Then, based on a predetermined path, they migrate gradually to different investments, often high-quality bonds, as a nominated retirement date approaches. It’s a popular default option across many defined contribution pension plans, especially those set up by employers, so if you haven’t made an active choice about where your pension is invested it’s possible that you’ll have been put into a fund or process that does this.

When it starts and how the lifestyling process works varies from one pension fund or provider to another. Usually, it happens over the course of five to ten years before a set retirement date, with the traditional objective to lock in on the cost of buying a guaranteed lifetime income from an insurance company known as an annuity. If the cost of an annuity rises in the important years leading up to retirement, then the pension fund should grow to reflect that, and if it falls then the fund can likewise decline in value.

Can pension lifestyling go wrong?

For many years this worked out well enough, but then two things happened. First, a rule making it compulsory for UK retirees to purchase an annuity with most of their pension pot was scrapped back in 2015. Since then, pension pots can be used in different ways. You can take larger lump sums, or even the full value, as cash, albeit that might be inefficient in terms of tax, or you can keep investing and draw a regular or flexible income generated from investment returns. In either of these circumstances a lifestyling fund or process may not be required, or indeed beneficial.

Secondly, and more recently, we have seen a seismic shift in the bond market. Bonds are essentially IOUs issued by governments and companies that pay a fixed rate of return, and their value is very sensitive to inflation and interest rates. The past couple of years has seen huge volatility as an era of very low interest rates gave way to far higher rates as central banks tried to rein in the significant inflation we have since the pandemic. Higher bond yields, and lower prices, have taken their toll on funds holding this asset class, and many lifestyle funds were no exception.

The saving grace for some people with lifestyle funds is they have done the job for which they are intended. The cost of buying an annuity has tumbled too, so they buy much the same level of income as before. That’s cold comfort, though, for anybody not wishing to buy an annuity at their previously stated retirement date, or at all. Some people wishing to keep investing their pot, or draw a sizable portion out, have been left exposed by a process that no longer fits with their intentions.

Should I stick with pension lifestyling?

Going forward, the outlook is not too bad for bonds, and hence the lifestyle funds that own them. The big move down in prices as inflation and interest rate expectations shifted is water under the bridge. Today, higher bond yields available are a valuable cushion against future volatility, and for those commencing or at early stage of the lifestyling process things may work out well. In pension planning, however, the focus must always be on your specific objectives and time horizon – when you are taking money from your pension and how you are planning on doing so.

To that end, lifestyling may still be very useful for some people. It can provide more certainty for those who do not wish to make investment decisions within their pension funds, and who have already made up their mind to buy an annuity at a selected retirement age. However, this applies to fewer people these days, at least at an early stage of retirement, and for others it could be counterproductive, or even dangerous, as it restricts growth and still carries risk of inflation and interest rates being higher for longer.

Those who think they are going to be continuing to invest but draw flexibly on their pension are likely to be served better by a strategy that retains a reasonable amount in shares. Alternatively, those wanting to draw lots of cash in one go could consider shifting gradually to a cash or money market fund as their date for doing so approaches as this is likely to be more effective in terms of managing volatility and the risks associated with inflation and interest rates. Indeed, some versions of lifestyling already offer these options, or otherwise build in more resilience to bond market volatility, so it is important to understand the specifics of your own pension plan rather than make any assumptions.

Can I stop lifestyling?

You can stop your pension from being invested this way, either before the lifestyling process has started or during. If you have lifestyling, your pension provider should notify you before you enter it, so you have the chance to opt out. You should also be able to either change the date when it starts – and make it a long time in the future – or alter the fund choice to something that’s suitable for your needs. Get in touch with your pension provider to discuss how your plan works and your options, and if in any doubt get some qualified financial advice as a mistake in the lead up to retirement can be costly.

Charles Stanley Direct has qualified advisers offering both pre-retirement planning and a Financial Coaching service to answer more straightforward financial questions.

A version of this article appeared on the This is Money website.