If life savings must last longer, our head of investment discusses whether pension plans need a rethink.
The Office for National Statistics this week mused whether it is useful to view 70 as the new 65, amid an uptick in longevity and a rising State Pension age – meaning our life savings need to last for longer.
interactive investor’s Great British Retirement Survey of 10,000 people found that more than half (52%) of non-retirees plan to keep working into retirement, either part-time or through self-employment. This may in part be because retirement pots are not going to provide enough income, and this could also link back to decades old decisions about retirement and investment strategy.
A 15-minute conversation, potentially 20-plus years ago, with an IFA who probably mentioned default managed funds, what retirement age you wanted and lifestyling to minimise risk… Any recollection?
But this conversation is one that thousands of us have had at various times over the course of our working life, and it has the potential to cost some of us a fortune if we don’t engage with our investments.
Pension lifestyle, sometimes known as a glide path, is an approach taken to reduce your exposure to risky assets such as equities in the 5-15 years before your chosen retirement date, moving you gradually into gilts and/or cash. This was potentially a good idea for investors in the bad old days, pre-pensions freedoms, where most people bought an annuity when they reached their nominated retirement date - as it avoided a situation where equity markets crashed just before converting your entire pension pot into a fixed income stream.
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However, the advent of pension freedoms means that most people now invest throughout their retirement, rather than buy an annuity, so lifestyling could actually cost you a significant amount of income. And bear in mind that lifestyling was based on your chosen retirement date – which may well have been the aspirational 55-60 when we were younger, rather than the new state pension age. This means that people could be inadvertently moving out of equities into bonds and cash from their mid-40s.
How much difference does it make?
Based on the 2019 Barclays Equity Gilt Study, the average real return over the past 10 years is 5.8% for UK stocks, 2.7% for gilts and -2.5% for beleaguered cash savers (where inflation significantly exceeded the average return available). Using these numbers, if you had taken the pension lifestyle option which rebalanced your portfolio and reduced your equity exposure by 10% each year, and put 6% of that into gilts and 4% into cash, you would have generated a return of just over 40% - turning £100,000 into £140,493.
If you had left it invested fully in equities, your portfolio would be worth £35,000 more - £175,734. Of course, this involved a period in which there was a bull run for equity markets and negative real returns on cash, making it an obvious time when this glide path option would have been a bad thing for investors.
A lifestyle approach would have been a better thing to do in the previous 10-year period, which Barclays aptly described as the lost decade for shares!
During the period 1998–2008, according to the 2009 Barclays Equity Gilt Study, UK equities had an annual real return of -1.5%, while gilts and cash both returned 2.4%. Being more cautious then would have saved you from losing money, with the pension lifestyle option turning £100,000 into £102,515 – while remaining investing in equities throughout resulting in your portfolio falling to £85,973.
What’s right for you?
A pension lifestyle plan is designed to protect you from market jitters – that is what it’s there to do. However, when you consider (although past performance is no guide to the future) that over an average 10-year period, equities have outperformed cash 91% of the time, according to the Barclays study, you need to be sure that it is the right thing to do.
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Absolutely, if you are intending to buy an annuity and have a hard stop at your chosen retirement date, then some sort of risk mitigation strategy is an insurance policy and is likely to help you sleep at night. However, if you’re intending to invest throughout your retirement, then your investment horizon should allow you to take more risk.
Dust off those decade old decisions
The most important thing to do, however, is to check your pension policy and dust off those decades-old decisions. Knowing where you are invested, what retirement date you’re working towards and whether you have a pension lifestyle option is essential.
This will hopefully all become second nature for investors when the pensions dashboard is implemented – but until then the onus is on everyone to investigate any past decisions so that you can make a more informed choice for the years that remain ahead of you. Being aware and engaged could make a huge difference to your financial future.
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