Feature – Lifestyling pensions

If you read nothing else, read this …
• Most defined contribution (DC) pension providers offer lifestyling, in which the funds are invested in equities to start with, and then moved gradually into fixed interest or cash over the last few years before retirement.

• It is popular as a default option, and may be compulsory for the pensions to be sold as part of the Treasury’s planned suite of stakeholder investments.

• It is sold by providers as a “leave it to us” option, but this can cause problems if people retire earlier or later than originally planned.

‘Lifestyling’ is one of those jargon words that the insurance industry loves. The idea behind it is that the investment mix in a defined contribution (such as a group personal pension or a stakeholder pension) fund in the years running up to an employee’s retirement it is automatically altered away from equities towards gilts and cash. At the Prudential, for example, there are various lifestyle options.

For Pru’s Lifestyle Option 1, a countdown starts eight years before selected retirement age, with progressive moves from equities into fixed interest over the following five years; over the final three years the remaining amounts in equities are gradually switched into a cash fund. Alternatively its Lifestyle Option 10 invests initially in equities and then 10 years before retirement age the investments are automatically switched in preset proportions at monthly intervals to the Retirement Protection Passive Fund. The message in the Pru’s literature is that with these lifestyling choices there is “less need for you to take proactive investment decisions”.

Lifestyling is likely to be compulsory for the pensions to be sold as part of the Treasury-approved suite of stakeholder products, following the recommendations of the Sandler Report on retail investment. As recently explained by the Financial Services Authority, it will be for schemes to decide on their own approach, but it is likely that “lifestyling will have to begin five years before retirement and that retirement will be taken to be the date specified on the contract”.

Iain Henshall, employee benefits consultant at Towry Law, points out that this will compound the flaws that already exist in many lifestyle plans. If an employee decides to prolong their working life “their money will be in cash or a low-risk fund over those extra years, and they will lose out on equity growth”.

He is more relaxed about the consequences if an employee decides to retire early. “You are going to be in no worse a position than if you had been in a balanced managed fund throughout.” Henshall also thinks it is unwise to sell lifestyling as the “never think about it again” option. “You do need to take a more active approach, if original assumptions change.”

Richard Stroud, chief executive of multi-employer pension fund the Pensions Trust, is far more critical. “With some administration systems,” he says, “when somebody changes their actual retirement date, the lifestyling programme goes backwards as if the new retirement date was the original planned date. It then works out the shortage in bonds and carries out a large transaction the following month.”

This means that a chunk of equities will be sold all at once – which could mean a major loss to the employee if the market happens to be down on that day. Stroud would like to see some tight requirements for lifestyle arrangements, with products that are more flexible in terms of retirement age. He concludes: “If retirement dates change, then switching should be [conducted] over the remaining period.”