Do you have a lifestyle problem?

Perhaps I should make it immediately clear that I’m talking about workplace pensions. The lifestyle problems I’m referring to are not about wearing this season’s Vogue-ratified designer labels, jetting off to sufficiently exclusive holiday destinations, subsisting mainly on grains, nuts and fungi that most of us haven’t heard of, developing perfect abs and pecs, using only state-of-the-art tech, and that sort of thing. Do you have a lifestyle? I don’t. I just have a life.

In the world of workplace pensions, the word ‘lifestyle’ has a specific and important meaning. Typically, a relatively modern defined contribution (DC) pension scheme will have some kind of lifestyling as its default investment option. Lifestyling is the process whereby pension savings are automatically gradually switched to lower-risk assets as a member approaches their selected retirement date. To a greater or lesser extent, the emphasis shifts from growth to stability. Depending on the provider, lifestyling can start as far from retirement as 15 years, or as close as three years.

Until the pension freedoms were introduced in 2015, lifestyling was straightforward. The majority of people in a DC scheme used their fund to buy an annuity — a secure income for life — so lifestyling targeted this outcome and usually involved moving 75% of the fund into long gilts and 25% into cash. Annuity rates are linked to 15-year gilt rates, and the assumption was that retirees would want their maximum tax-free cash lump sum.

Nowadays, once people reach age 55, they have three main options when accessing their DC pension savings:

  1. take it all as cash
  2. buy an annuity
  3. move their money into a ‘flexible access drawdown’ account and make withdrawals as and when it suits them

People can mix and match among these options, 25% of their pension savings can be taken as tax-free cash, with the remainder taxed as income. This increased flexibility is a fantastic development for the millions of people saving in DC pensions.

However, the pension freedoms were enacted without prior industry consultation. Providers had to scramble to innovate, creating new lifestyle sequences or ‘glidepaths’ to target encashment or flexible access in retirement.

After the initial ‘dash for cash’ that saw thousands of small funds liquidated, surveys by the Financial Conduct Authority (FCA) and HMRC have shown that flexible access is now the most popular way of taking pension benefits by far – and its popularity is still increasing.

Of course, if you want to access your pension benefits flexibly, you need investment growth after retirement to counteract the depletion caused by taking income. Broadly, this means maintaining some exposure to equities, but not as much as during the growth (pre-lifestyle) phase.

Here come the problems:

  • Hundreds of thousands of people in older workplace pensions don’t have any lifestyling at all. This means they are vulnerable to market downturns at a pivotal time in their life, and their income in retirement could suffer severely as a consequence.
  • Numerous unmodernised default funds have a single lifestyle glidepath targeting annuity purchase, which means there is too much de-risking happening for people who want flexible access. Switching to a different fund would enable these employees to fare better.
  • Conversely, in more modern schemes, risk-averse people who would like to annuitise may find themselves in a default glidepath that targets flexible access.
  • More generally, huge numbers of people just don’t understand their options. Many employees haven’t even considered how they’ll take their pension savings, never mind worked out if their default fund’s lifestyling is appropriate for them.

Fortunately, these are not insurmountable problems. Here are two pointers for you:

  1. Employers should ensure that they comply with the Pensions Regulator’s stipulation that their workplace scheme leads to good member outcomes. This may require radical action: out-of-date and poorly functioning schemes need to be thoroughly overhauled or replaced.
  2. Employees — in this case, those approaching retirement in particular — should be offered financial education. It is essential that they are given the opportunity to understand their options. A lot of people feel intimidated by retirement issues and, without assistance, do that thing ostriches reputedly do. Pensions shouldn’t be daunting and financial education brings reassurance.

So, lifestyle problems? It’s not about how ingeniously your décor is complemented and counterpointed by accent pieces snapped up at a Parisian flea market. It’s about ensuring people are aware of how their pension savings are invested as they reach the end of their working life. Being in the wrong lifestyle glidepath, or having no lifestyling, could lead to diminished income in retirement and years of financial insecurity.

This article was first published with REBA on 3 August 2018

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