If you don’t understand what this means, you could lose tens of thousands of pounds in retirement savings. Yet most people have never even heard of it.
The jargon is called “lifestyle”. This is an automatic process that applies to most business and personal savings as savers approach retirement.
Usually this is the default option, so it happens automatically even if it’s not the right thing for you.
Unless you understand what that means, you could find yourself sleepwalking into a retirement disaster.
The lifestyle is designed to prevent a last-minute stock market crash from destroying the value of your nest egg shortly before you retire.
It does this by regularly moving your funds out of the stock market into low-risk investments such as bonds and cash over the last 10 years of your working life and into retirement.
Yet, although lifestyle reduces your investment risk, it can significantly reduce your returns and ultimately the size of your retirement capital and retirement income.
Typically, your pension fund will contact you to tell you that your savings are going to be invested in a “lifestyle profile”.
It may indicate that it will move your money into pre-selected funds as you get closer to your chosen retirement date.
However, these letters often fail to specify that this involves regularly moving your money from stocks to cash and bonds.
Switching to low-risk, low-return bonds could backfire by offering a much lower investment return on a retirement that could last up to 20 or 25 years, said Tom Selby, head of policy at retirement with AJ Bell.
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Lifestyle default pension funds underperformed the stock market, Selby said. A typical default lifestyle fund selection would have turned £10,000 into £20,964 over the past decade, but the most popular global fund investment sector would have returned £31,420.
Measured over 30 years, the lifestyle would have returned £76,480 versus £101,990 from a global equity mix. That’s £25,510 less.
Selby said: “The lifestyle concept belongs to a bygone era, when savers were forced to buy an annuity in retirement with their pension.”
After the 2015 pension freedom reforms, most retirees now leave their money invested by direct debit, taking money as needed to fund expenses.
Selby is issuing the warning now because the city’s watchdog, the Financial Conduct Authority (FCA), is consulting on plans to force providers to impose lifestyle as the default option on personal pensions.
“If so, millions of people could end up investing in a suboptimal fund for decades,” he said.
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Andrew Tully, technical director of pensions at Canada Life, said the default options may work for some, but the risk reduction may be bad for those who opt out. “It doesn’t make sense to move into bonds and cash in your late 50s and early 60s because you could miss up to 30 years of stock market growth.”
Obtaining a higher yield is now all the more important as inflation rages on.
As more people work past 65, Tully warned that some default options have been automated on the wrong target date.
Taking too little investment risk as you approach retirement could be even more costly than taking too much, he added.
It’s worth checking your business and personal pensions to see if you’ve ever moved to a low-risk default option, said Becky O’Connor, head of savings and pensions at Interactive Investor.
“Read all correspondence carefully to decide if you want to agree to this, and alert your pension fund if you don’t,” she said.