Michael Roberts FPFS
Leaving your pension on autopilot could be dangerous
Updated: Nov 17, 2020
Many workplace pensions, and indeed personal pensions, set up over the years have included an option commonly referred to as “Lifestyling”, or “Lifestyle Profiling”. The idea behind this is to invest in more adventurous growth focussed funds initially, but to gradually switch to safer funds as you get closer to retirement age.
It is intended to crystalise gains made over the years and prevent your fund suddenly plummeting in value just before you retire, when you may have insufficient time to wait for it to recover. Often Lifestyle switching happens automatically, and you may not be aware of it.
This might sound sensible; however, this historic practice is a somewhat blunt tool and could be problematic if left unchecked.
Let’s take a look at why Lifestyling may not be desirable.
Lifestyling is normally linked to the age at which you intend to retire. This is fine in theory, but what if your plans change? When your plan was set up at outset, it may well have been linked to a default retirement age of, say, 65. However, what happens if you now plan to retire earlier at 60, or indeed later at age 70? The Lifestyling function will continue merrily switching your pension into a different, usually lower risk selection of funds at the wrong time. So, it’s worth checking the planned retirement age of your pension and changing it if necessary. If your retirement plans change, don’t forget to let your pension provider know.
Many of us will be familiar with the wise words “buy low, sell high”; in other words, avoiding selling your investments while markets are at a low point. Unfortunately, Lifestyling is generally oblivious to this. If your pension starts to switch into safer funds 5 years before retirement, and that happens to coincide with another pandemic, financial crisis or whatever other apocalypse du jour you care to imagine the stock market may suffer from, your pension will continue slavishly selling your investments at what could be the worst possible time. To add insult to injury, it may then be buying into safer investments such as bonds, that may be comparatively expensive at that time.
Retirement Income Options
Lifestyling has been around a long time; certainly since the time when the purchase of an annuity seemed to be the norm. Times have changed, and while annuities have fallen in popularity, many people have chosen to instead leave their fund invested and rely on future investment performance to help fund their pension income; a process known as drawdown. If you plan to rely on drawdown, it is quite likely you will wish to maintain a certain level of investment risk within your portfolio, to improve the likelihood of your fund being able to sustain the income you wish to draw over the long term. Switching progressively into safer investments such as bonds as you approach retirement as would have been a sensible option if you planned to buy an annuity, and quite possibly selling down investments at a bad time as described in the last point, may not be the ideal outcome; requiring you to switch back into riskier funds to generate the growth you need at retirement.
Tax Free Cash Withdrawals
Whilst some providers have improved their Lifestyling option such that they now allow you to choose whether you intend to buy an annuity, go into drawdown, or take out the entire fund as a lump sum, some pensions will automatically assume that you wish to take the maximum tax free lump sum of 25% of the fund, and will switch this into cash to protect it from the vagaries of the stock market. This is fine if that’s what you intend to do, but if you have no need for the lump, then perhaps you would decide to leave the lump sum invested or draw it out in smaller amounts over the years. If your pension has switched 25% of your fund into cash on the assumption you’ll take it all out in one go, this may not be ideal.
Lifestyle switching is not necessarily in itself a bad thing, if monitored and used correctly it can be beneficial. With many pension plans set up decades ago, and with pensions legislation and retirement trends having changed significantly over this time, it is vital to check up on what your pension is doing. Don’t assume it is acting in your best interests; that may not be the case. The Lifestyling autopilot will continue to take you to the destination you originally specified, but if things have changed, your pension may be acting entirely against your best interests.
Ask your pension provider:
- Does my pension include automatic lifestyle switching?
- If so, is this feature set up, and when is it due to commence?
- What is the target retirement age of my pension?
- How is the pension currently invested?
- How will the pension be invested at my specified retirement age?
- Can the Lifestyle switching take account of whether I intend to buy an annuity, go into drawdown or withdraw my fund as a lump sum?
- Will the Lifestyle switching make provision for taking the 25% tax free cash lump sum at retirement by putting this into cash?
Once you understand the answers to these questions you can begin to assess whether any existing Lifestyle switching arrangements would be suitable given your current circumstances and plans for the future.
Don’t forget, the whole essence of Lifestyle switching is that it can start decades before your planned retirement age, so don’t wait until you get to retirement to check it out.
IMPORTANT: This article is not investment advice and is intended for information only.
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