Can you glide to a happy retirement?

16th October 2013

Many employer pension schemes are set up these days without advice being available to members.  In the absence of advice such schemes offer a “Default Fund” and many include a “Lifestyling Option”

A Default Fund will be that which receives contributions if the member does not make a personal selection.  The default fund option can vary quite dramatically between pension schemes.  A key influence will be the scheme provider; however the choice of default fund can also depend on the demographics of the employees.

A “Lifestyling option” is intended to reduce the risk taken in the pension fund as the member approaches retirement, specifically the risk to the member of the value of their pension pot falling dramatically just before they buy an annuity. This is a relevant risk; you have probably seen stories where disaster has befallen someone just before they retired.  However such examples are, thankfully, relatively rare. For most people personal planning and advice offers a more appropriate and effective solution than a lifestyling option.

Lifestyling plans work on a ‘glide path’ which reduces exposure to assets that are considered higher risk over a period before the member’s selected retirement date; this period is usually between 5 and 10 years but will vary from scheme to scheme. The path will be automatic and inflexible and it relies on some important assumptions:

  • That the selected retirement age remains appropriate
  • That the assets chosen are appropriate
  • That the member will choose to buy an annuity

The first of these is important because how many of us can be sure, when we start paying into a pension plan, what our retirement age will be? Even where there is some confidence that retirement will be at, for example, State Pension Age, we don’t know at what age that will be.  The goal-posts have been moved more than once already and there is every chance they could move again.  A ‘glide path’ based on an assumed date set 20, 30 or even 40 years in advance is unlikely to reflect reality.

The second issue impacts on returns; there is no way to predict the investment performance of different asset classes in advance.  Over the last 3 years or so anyone switching from equity to bonds will have lost out in a big way on investment returns. The arbitrary switching of a pension fund to “low risk” funds runs the risk of reducing returns over the life of the plan by a dramatic amount.

The third issue acknowledges that buying an annuity is not the only retirement solution.  An individual may choose to defer annuity purchase in favour of a drawdown strategy.  In these circumstances adopting a Lifestyling Glide Path could be entirely the wrong option.

Research from the US (The Glidepath Illusion – Rob Arnott 25/09/12) suggests that there are very few periods in the past that show the lifestyling approach would be more effective than alternative, more personalised, strategies.

We believe a process that includes proper planning to identify, qualify and quantify goals, establish the best way to achieve them, followed by regular reviews of the agreed strategy to ensure that the plan remains on track is far more likely to get our clients to where they want to be.