What is pension lifestyling? Bond crash reveals de-risking dangers

What is pension lifestyling? The little-known strategy that can have a big impact on your fund in the run-up to retirement

The bond market crash in recent months has drawn attention to a little-known or understood investment strategy that many workers are ‘defaulted’ into in the run-up to retirement.

Some older workers have discovered to their horror that they are sitting on huge losses right on the brink of retirement, which they might be forced to delay as a result.

This is because late in their working life, savers in pension schemes typically see their pots shifted out of stock markets and all or part way into bonds, which have historically been regarded as the ‘safer’ option.

The process is known as lifestyling, de-risking, or sometimes target-dating, but when it starts and how it progresses varies so you will need to ask your scheme or at the very least stay alert to any communications about it.

Of course, you should always read anything that arrives from your pension scheme. But it is more crucial in the decade or so before retirement age, as the investment approach being used could have a big impact on your eventual pension fund.

Note that lifestyling affects people in ‘defined contribution’ pensions, where you build a pot invested for retirement, not ‘defined benefit’ or final salary schemes, where an employer is responsible for paying you a guaranteed income for life. 

> How has the bond market crash impacted YOUR pension?

What do you need to know about lifestyling?

Your pension scheme will ask you about your plans and choices regarding your retirement date, and whether you want to take your pension pot as cash, use it to buy an annuity and get a guaranteed income for life, or keep it invested in an income drawdown plan.

Not answering means you are likely to be defaulted into whatever investing strategy your scheme deems most suitable before you retire.

Anyone who wants to keep their pension fund invested perhaps for decades to come in retirement might want to consider whether it is better to opt out of ‘lifestyling’ altogether and stick with stocks, which are riskier but have more potential for long-term growth.

On the other hand, plummeting bond prices are creating opportunities for new buyers, so moving into them might be great timing for people just starting the lifestyling process now.

It is worth stressing that the employers and pension firms running workplace schemes ‘lifestyle’ funds with only the best of intentions for their members.

The idea is to protect savers against abrupt downturns when they are just about to start tapping their pensions.

Meanwhile, all is not lost for those savers who have taken a hit during recent bond market ructions.

The sell-off in recent months is being driven by worry that interest rates will have to stay higher for longer to combat inflation.

But those same interest rate rises have also made annuities a more attractive option again, with better deals now available after years when they were in the doldrums.

So, what if your pension hasn’t started being lifestyled yet, but you want to know more and be forearmed about what is to come?

Or what if you have just realised you are midway through the lifestyling process already and want to know whether to stick with it, or are on the brink of retirement and need to know your options now? 

We asked pension experts to explain all the practical ins and outs.

When does pension lifestyling typically start?

Usually this happens between six and 10 years from the retirement age you have either chosen or your workplace scheme has selected for you.

Whether you are in an in-house employer scheme, or one run by a big pension firm or mastertrust, they are likely to notify you before you enter the de-risking phase, so you have the chance to opt out.

If you haven’t heard from them about this, check your personal pension details online or give your scheme a ring to find out the start date.

It’s really important people think about their selected retirement age or the age that they’ve been defaulted to if they didn’t select one, says Hymans Robertson partner Rona Train.

‘This impacts when the administrator will start to de-risk them. If they change their selected retirement age once they’re in the lifestyle strategy, they may be either de-risked if they bring it forward or re-risked if they push it back.’

Workplace pension provider Aegon says it starts lifestyling – changing the asset allocation of a pension – from six years from someone’s chosen retirement date.

‘This timeframe can vary depending on the product and strategy the customer is invested in, and will be automatically updated if a customer chooses a different retirement date.’

Lifestyling might begin automatically after you have received a letter, so you need to be on the lookout and be ready to make decisions.

Aegon says its letters encourage members to review their pension, consider their retirement goals, and check they are in the right investment strategy.

‘It’s vital that customers read all the information sent to them by their pension provider, and seek help from a financial adviser if they don’t understand or call their provider for more information,’ adds the firm.

Will you be completely moved out of stocks and into bonds or cash?

A full transition out of stocks used to happen before the pension freedom reforms in 2015, which was when people were handed direct control of their retirement funds instead of having to buy annuity.

Before that, schemes tended to lifestyle all pensions in the same way, says Rona Train of Hymans Robertson.

‘Most schemes ended with a position of 75 per cent in bonds and 25 per cent in cash as the vast majority of people took their maximum allowable tax-free cash lump sum and then bought an annuity with the remainder.

‘This changed after 2015. Some strategies still target only bonds and cash at retirement but many have developed to target a more balanced portfolios of shares, bonds and other asset types.

‘These are designed to be more suitable for people who will opt to draw down an income after the point of retirement.

‘A limited number of lifestyle strategies target 100 per cent in cash at the point of retirement. These are largely in schemes where members are expected to have small pots when they retire and to take all of these pots as cash when they retire.’

Aegon says it gives people three main options on what to do with their money at retirement: buy an annuity; take it as cash; and withdraw it flexibly.

‘The asset mix or investments held for each of these three options will vary. For example, a lifestyle fund targeting an annuity will generally move to mostly bonds and cash.

‘This is because bonds and annuity rates have an inverse relationship (when bonds fall, annuity rates typically increase and vice versa) which gives greater certainty as to the level of annuity you can purchase.

‘If you’re targeting cash, the lifestyle will move to mostly cash. If you’re targeting flexible drawdown, it is likely to be a mix of bonds, cash, and stock markets.’

Dan Smith, head of workplace distribution at Fidelity International, believes it is important for there to be a de-risking process during the approach to retirement.

This is in order for people to access higher risk assets early in life while diversifying closer to retirement.

‘De-risking is driven by the change in member objectives,’ he says.

‘While a younger member is focused on growth with a high tolerance to risk, someone entering a drawdown product needs a more diversified growth strategy, but with less volatility and potentially an income target.’

If you stay invested in a income drawdown scheme in retirement, you need to reduce volatility because making withdrawals during more negative market conditions can have such a significant impact on your fund, explains Smith.

‘This can have a detrimental impact on the expected life of a drawdown pot in supporting an individual’s retirement and most drawdown strategies look to provide some stability to limit the impact of this risk.’

What if you want to opt out of lifestyling?

If you plan to stay invested throughout retirement, you might prefer to stay with riskier stocks, although as explained above you should still bear in mind the need to have a balanced portfolio and how you will manage withdrawals during periods of market upheaval. 

Nevertheless, you might want to make choices on this yourself rather than have them taken over your head.

It depends on your scheme, but if you want to opt out of lifestyling entirely you will probably have to move out of its default fund and invest in some of the other funds that it offers.

Workplace schemes run by external pension firms typically have a ‘walled garden’ of funds to choose from, but check the charges as they might be more expensive than the default one.

Rona Train of Hymans Robertson says if you are in an in-house scheme run by your employer, you should let its administrator know you want to opt out before the lifestyling process is due to begin.

‘In many cases, you can now do this online but you can also follow the more traditional route and phone up your administrator. You will normally be able to find your administrator’s details on your latest pension statement.’

Can you halt lifestyling midway through the process?

‘Some people who have already been lifestyled may wish to manage their pensions on their own,’ says Dan Smith of Fidelity.

‘They have the option to opt-out of their default strategy and instead choose their desired risk appetite and “self-select” their funds.’

But Smith warns the value of the investments in your pension and any income from them can go down as well as up, saying: ‘Pensions are a long-term investment and volatility is a normal part of long-term investing.

‘So, think carefully and consider talking to an authorised financial adviser before making any decisions.

‘Remember, withdrawals from a pension product aren’t normally possible until you reach age 55 (57 in 2028).’

Aegon notes that you can change where you are invested at any time, but you can’t backdate this.

‘The change will be made when you request it. Customers can either change their nominated retirement date to extend the lifestyle or change the whole investment/fund choice.’

If you are in your employer’s in-house scheme, they will also let you opt out of lifestyling at any time, but you will need to select where your money should go to and tell the administrator, says Train.

‘The change in investments will depend on where you are in the lifestyle (how many years you have until your selected retirement date) and where you decide to invest the money.

‘For example, if you’re close to retirement, you’re likely to have your money invested in a lower “risk” strategy. If you then move all their investments to equities (for example), you would effectively be “re-risking”.’

What should you consider before your pension is lifestyled?

1. Whether the retirement date your provider expects matches with your own goals

‘If it is earlier than when they might actually retire, there is a chance they could de-risk earlier than is necessary and so leave some growth opportunities off the table,’ says Smith.

‘Those approaching retirement should keep their pension provider updated with their planned retirement date to ensure the de-risking is targeting the right age.’

If you are de-risking via a ‘target dated’ fund, its name will quite literally make you aware of the retirement date that the strategy is designed toward, he points out.

2. Attitude to risk and personal objectives

‘Not all drawdown strategies should look the same and should be tailored towards the individual’s objectives,’ says Smith.

‘The decision to avoid lifestyling is an active decision, reflecting your own attitude to risk, akin to selecting your own investments.

‘It is important for individuals to be confident in the investment decisions they are making or to seek advice from an appropriate adviser if not.’

3. Paying for financial advice

Whether you opt to have your pension lifestyled is just one part of an overall investment strategy, says Aegon.

‘Capacity for loss, attitude to risk, tax considerations and future contributions are just a few factors to consider when selecting your own investment solutions.

‘Obtaining financial advice can be invaluable in ensuring all these are considered and the right option is selected for you.’

Have annuity deals recovered enough to offset bond losses?

Annuities provide a guaranteed income until you die. But they have been shunned for years due to poor rates and restrictive conditions, and after gaining a bad reputation on the back of annuity mis-selling scandals.

Most savers now keep their funds invested and live off withdrawals instead, despite the financial market risk involved.

However, the recent run of interest rate hikes mean annuity providers can afford to fund much more attractive deals, prompting a resurgence in sales.

> What should you bear in mind when buying an annuity?

Aegon says buying an annuity depends on matters such as if you want one for yourself only or for you and your spouse, or if you have underlying health conditions.

‘The movement in annuity rates is generally the inverse (or opposite) to that of government bonds (also known as gilts).

‘When gilt markets fell throughout 2022, annuity markets rose. So, whilst some gilt markets fell around 40 per cent over the last two years, annuity rates have seen around a 50 per cent rise over the same period.’

Best buy annuity rates generated on 5 October 2023 (Source: Hargreaves Lansdown)