Lifestyling – (sometimes called “life-cycling”) in DC pensions means adjusting the asset allocation of a pension pot to meet changing circumstances as people prepare to crystallise their pension pot(s). A crystallisation is a transaction which sees an encashment of pension units to release money to a member. This can mean drawing down the tax-free cash from a scheme or taking taxable with drawls or a combination of the two -known as UFPLS.
To answer the question posed in the title we need to look at how lifestyling protected retirement plans where people either choose to drawdown, leave their money to grow or to cash out their pot. We’ll also look at how lifestyling worked for people buying annuities though very few lifestyle strategies still focus on this area.
To date , research has been on what academics call an “ex-ante” basis, this looks at what is likely to happen, making lots of assumptions about the financial markets and savings behaviour. The alternative is to look back on an “ex-post” basis and find out what actually happened. Strangely, there is little research published on what has actually happened and this is because we know very little about what people have actually done with their retirement savings.
The FCA give us localized information about withdrawals
Apart from the FCA’s retirement income market data, we have little data on how people are spending their retirement savings from 55 onwards. The FCA data tells us how money is being taken out of personal pension pots but it does not tell us about the journey people are going on to bring their pots together, nor the final outcomes people end up with (their holistic plans including DB pensions, state pension and sources of income outside of pensions like employment, rents and dividends.
Annuity brokers give us localized information about annuitants.
We have some information from brokers like Retirement Line about people’s aggregate behaviour when annuitizing. This suggests that annuitants are sophisticated, exercising their rights to enhance annuities by evidencing poor health and using temporary annuities in the hope that rates will rise after QE ends. Annuitants take guidance but are rarely advised, financial advice is focussed on the ongoing investment of pension pots in funds and on cashflow planning. This too suggests careful buying from consumers prepared to take decisions on the tax-implications, investment timing and the sustainability of the strategies they employ.
Financial advisers give us localised information about the wealthy
Prior to the implementation of the RDR in 2012, advisers were more active in the mid-market and data from advisers was used to understand the purchasing decisions of a much larger proportion of the estimated 700,000 people crystallising their retirement savings each year. But the complex choices that have become available following the introduction of pension freedoms, coupled with the withdrawal of advisers from the mid-market means we are less aware of how people time their drawdowns and what they do to consolidate their savings into a later life financial plan.
There is very little published information about the pension lumpen!
We are not overly concerned about those who actively seek guidance on annuities or who purchase financial advice and plan their cash-flows, this blog asks about the impact of the lifestyling process on people who are not paying much attention to their pension. These people are potentially vulnerable – either to market risk or to its absence. I call them the pension lumpen – “lumpen” to me means “not interested in changing things” but “wanting change to be made for them”.
Because the pension lumpen don’t take advice or guidance (only 10% of us even take up our free Pension Wise appointment), lifestyling is very important to them. Strangely, we know very little about how effective it has been.
There is no pension census!
We have recently had a census, that will tell policymakers how people were living in early 2021, but we have no census of pensions behaviour and this makes the design of pension policies and pension schemes difficult.
Broadly speaking, those concerned with organising the pre-retirement stage of a pension lifecycle can adopt one of three strategies (with a fourth emerging)
- Set a strong rules-based default lifestyle which assumes a consensus on when benefits are taken and how.
- Establish a variety of lifestyle strategies and encourage self-selection through clear communication and guidance.
- Trust customers to be savvy and make it easy for them to execute their own strategy (with support where needed)
A fourth option, which may emerge as part of CDC, is for occupational DC schemes to start paying pensions from a collective pool that could be created from the pension pots of a DC scheme or from a variety of disconnected savers.
The evidence based investor needs evidence. “Who knows!” is not evidence, it is an admission of ignorance. For those who design our pension schemes to know which option to pick, they must have evidence of what people have actually done and are likely to do in future – unless an intervention is made.
Do we need a pension census?
Perhaps we need a pension census for those who are between 55 and 70 to find out the decisions they have made or are planning to make.
At AgeWage we are embarking on a study of lifestyle strategies and testing them in times when savers have faced market stress. For the most part this stress is evident through sharp declines in the value of equity markets (market crashes), but there are also periods where the cost of annuities surges which are no less devastating to those on their way to buying one. The cost of annuities increases in line with falls in interest rates.
Imagine you’d been expecting to draw your annuity in the second half of 2008. If you had been invested in a lifestyle with annuity protection your fund would have surged with the fall in interest rates, your annuity wouldn’t have got cheaper but your fund should have given you the capacity to buy the same amount of lifetime income. Well at least that is the theory, but where is the proof of the pudding?
What we’ll be doing is looking at large DC pension schemes and finding out what those between 55 and 75 have actually been withdrawing (rather like the FCA have done with personal pensions). We will then look at how the lifestyle strategies they employed , protected them whether they (a) cashed out, (b) drew money down in stages, (c) spent their savings on an annuity. We’ll also look at how people fared when staying in a fund ,whether they opted out of lifestyling and if they stayed in a lifestyle strategy, how this impacted their savings.
Our initial research demonstrates that different lifestyle strategies lead to remarkably different outcomes – especially at times of market turmoil. They also show that being in the wrong assets at times when markets are calm can be as damaging as being over-exposed to market risks when markets are volatile. If people understood the effect of lifestyling, they might be less sanguine about it. As it is, many people close to retirement appear to be in strategies radically different to those they have been in when younger and often with no idea of what is happening to their money.
This situation needs to be addressed if many people aren’t to find lifestyling working against their later-life interests. Thankfully, most large DC schemes are addressing this problem in one of the three/four ways above.
For trustees, IGCs and GAAs we hope our research will be a reminder of the importance of the final years of accumulation and the need to ensure that lifestyle strategies are doing more harm than good. We hope to extend our work to look at how investment pathways are interacting with lifestyling strategies and whether our limited census can lead to greater consensus.
We hope that following a reading of this paper, a DC trustee fiduciary looks to better understand what members of his/her scheme are doing when crystallising or transferring benefits. This might lead to trustees conducting a pension census to understand what is happening today and what people intend to do tomorrow.