Lifestyle pension funds have lost 9 percent in 4 months and things could get worse. De-risking on the run up to retirement in company pension plans traditionally uses lifestyle pension funds that invest in bonds. 

These funds are precariously placed in a bond sell off. An estimated 720,000 pension savers are invested in these funds which are designed for members who will purchase an annuity when they retire.  Are lifestyle pension funds still appropriate for the company plan?

What should employers do? Nathan Long – Head of Corporate Pension Research at Hargreaves Lansdown; ‘Successful pension investments in the run up to retirement should avoid a disaster scenario. This is a drop in investment value close to retirement that leaves employees no choice but to delay retirement or limp through with less than they had planned for. The correct investment mix depends entirely on the retirement plans of the member. The best way for employers to help staff avoid a nasty shock late in the day is to offer access to on-going workplace financial education. Employees can then plan for themselveswhat suits them best.’

Lifestyle pension funds have lost 9 percent in 4 months

Lifestyle pension funds are widely used as part of the default investment strategy in company pension schemes. Many savers who sit in the default option are gradually and automatically switched into these funds as they approach retirement. The funds invest in government and corporate bonds, and have consequently been hit by the recent bond sell off. The 10 year UK gilt yield has risen from 1.33 percent on 30thJanuary to two percent on 12thJune. The average lifestyle pension fund has consequently lost 9 percent of its value over this period.

Things could get worse. These lifestyle pension funds have done very well in a low interest rate environment, returning 50 percent on average over the last five years. This reflects the strong performance of the bond market on the back of loose monetary policy. However there is a big question mark over how these funds will perform in a rising interest rate environment, and the recent sell-off could be just a taste of things to come. This is compounded by the fact that the recent pension freedoms will mean many pension savers now won’t be buying an annuity. Lifestyle pension funds and the pension freedoms – are they still appropriate? Lifestyle funds are designed to move in the opposite direction to annuity rates. This is evidenced by the fact that over the last 4 months annuity rates have risen by five percent at the same time lifestyle funds have fallen by 9 percent. The idea is that if annuity rates fall, pension savers approaching retirement don’t lose out because their fund is going in the opposite direction – up.

This strategy has worked well in the rising bond market we have seen in recent years. Annuity rates have fallen by 13 percent, but lifestyle funds have risen in value by 50 percent over the last five years. However the future may not be so rosy for investors in these funds for two reasons: If interest rates rise, these funds are likely to lose money. In this scenario, pension savers would in theory be compensated by rising annuity rates. However, In light of the new pension freedoms, far fewer pension savers will now be buying an annuity with their pension pot. Only 8 percent of Hargreaves Lansdown clients bought an annuity in the first month following the pension freedoms. Use of our online retirement modeller points to a far greater appetite for secure income,  however it is clear that annuities are no longer the prevalent solution they once were.

What should employers do?

 Understand where their company pension default strategy invests. The focus should be on the period on the run in to retirement as well as the early years of saving. Existing members may have a different strategy to newly enrolled staff, so employers should be sure to understand the full picture. Review the default strategy. Whilst a default investment cannot be right for everyone, employers should ask their advisor to review the strategy in light of the new pension freedoms to ensure it is still suitable. Help staff to make the right decisions. The pension freedoms mean that no default fund will suit all members in the scheme. Employees must make decisions suitable for their plans for retirement. Employers can help out by providing on-going financial education throughout their career so employees can make confident decisions when the time comes.