Do you know what your company pension scheme is invested in?

Why the default option in your pension scheme may not suit your retirement plans
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If you are a member of a Defined Contribution (DC) pension scheme through your current or former employer, there is a good chance you are in a default investment option. A lot of schemes apply a default investment strategy known as “lifestyling”, which gradually moves your pension out of equities and into lower-risk assets such as bonds and cash in the years leading up to your selected retirement date.

'Inflation does not retire when you do'

On the surface, this sounds entirely sensible. Nobody wants to see their pension pot fall by 30% the year before they retire. But here is the issue we want to flag: the lifestyling default was designed for a world that, for most of our clients, is no longer relevant.

What Lifestyling Is Actually Designed For
Lifestyling strategies were originally built around a specific assumption: that on your retirement date, you would take your tax-free lump sum and use the remainder of your pension to buy an annuity i.e. a guaranteed income for life from a life company.

If that is your plan, lifestyling makes a lot of sense. Annuity rates are linked to bond yields, so holding bonds in the run-up to retirement broadly hedges the cost of the annuity you are about to purchase. A market fall just before you retire would damage your equity-heavy fund but would typically be offset by a rise in annuity rates.

It also suits the trustees of the scheme. Their duty is to manage risk for the average member up to the point of retirement. Once you take your benefits, their job is done. A smoother glidepath into retirement reduces complaints, reduces regulatory risk, and is straightforward to administer across a large number of members. From a trustee’s perspective, lifestyling is a perfectly defensible default.

The Problem
In practice, the overwhelming majority of clients we advise do not purchase an annuity at retirement. They take their tax-free lump sum and transfer the balance of their fund into an Approved Retirement Fund (ARF), drawing income from it over a long period.

Once your money goes into an ARF, your investment time horizon is not the day you retire, it is the rest of your life. For someone retiring at 65, that could easily mean a further 25 to 30 years of investing, often longer. You are simply moving from accumulating a pot to drawing an income from it, while the bulk of that pot continues to be invested and grow tax-free.

If lifestyling has moved you 75% into bonds and cash by age 65, you are starting a 30-year investment journey from a deeply defensive position. You are then required by Revenue to draw a minimum of 4% per year from age 61 (rising to 5% from 71, and 6% on funds over €2 million). Drawing 4–6% a year from a portfolio yielding low single digits is a recipe for steadily eroding the real value of your fund.

The Hidden Cost of Being Too Cautious Too Early
It is easy to focus on the risk of a market fall and forget about the risk of your money simply not growing fast enough. Inflation does not retire when you do. At 3% annual inflation, the cost of living roughly doubles over 24 years. A retirement income that looks comfortable at 65 can feel uncomfortably tight at 80 if the underlying fund has not kept pace.

Equities, despite their short-term volatility, remain the most reliable driver of long-term real returns. Stripping them out of a portfolio that still has a 25 to 30-year horizon is, in our view, a far greater risk than the short-term volatility lifestyling is trying to protect you from.

What Should You Do?
None of this means lifestyling is wrong for everyone, and it certainly does not mean you should be 100% in equities the day before you retire. The right answer depends on your overall circumstances: the size of your fund, your other assets and income, how much you intend to draw from the ARF, your appetite for volatility, and your plans for any remaining capital. This is something we review as part of your overall financial plan.

If you are currently in the default option in your current or former scheme and we have not reviewed it as part of your plan, please let us know and we will be able to assess your options.

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Disclaimers 

• This document is intended as a general guide and does not constitute advice. Please contact us to arrange advice specific to your own situation. 
• All figures, calculations, statistics and tax rates are based on indicative rates as at the date of this article which is noted above.
• Please note this document is not meant to be a comprehensive assessment of the tax rules that could apply under all scenarios and it is possible the tax rates outlined above may change and may be different depending on the individuals’ circumstances. 
• Worked examples are intended as a guide only and the actual return will depend on the product available at the time and the tax rates applicable to your own situation. 
• Examples are for personal investors. Different tax rules apply for Corporations and Charities.