Who knows!
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.
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Henry, I would suggest asking the question “has lifestyling worked? ” is an irrelevance now. Back in the very early 1990’s I set up one of the very first lifestyle DC trust schemes. At that time people reaching normal retirement date had three options, a) defer retirement, b) use 100% of the DC pot to buy an expensive annuity (impaired life annuities were an extreme rarity) or c) Draw off 25% tax free cash, with the remaining 75% purchasing an annuity. The vast majority took option c). So the original lifestyling was to automate the asset balance to arrive at 25% cash, and typically 75% in long dated gilts and linkers. The intent was to ensure a degree of stability of purchasing power at retirement when fixing up the annuity component which could take up to 3 months, but also to ensure the tax free cash could be forwarded within days of the actual retirement.
Roll on 30 years and with the advent of Pension freedoms in 2015 there are now multiple options which were not around in the early 90’s. As a result lifestyling is now an anachronism and in need of urgent replacement. With the advent of massively increased computing power, I am certain the development of online modelling is the way forward for the more sophisticated and CDC is the way forward for the “Lumpen” as you call them.
So trying to establish whether or not lifestyling worked will not change the reality of what it did achieve, nor the fact it is no longer relevant for a modern DC scheme.
When I was last involved in reviewing DC default design as a trustee, we started with consideration of both what past members had done and how future retirees might make different choices, particularly as they are likely to have less DB accrued. I think that approach is key, i.e. starting with the desired decumulation options and then looking at accumulation routes.
Apart from running a survey of your own members there are some generic reports to consult. For example…
https://thepeoplespension.co.uk/media-centre/policy-research/new-choices-big-decisions-5-years-on/
This report is a really interesting read as it gives insight into motivations, attitudes and actions on using pension freedoms.
An interesting tread, for many of the wrong reasons. Not one single mention of means-tested benefits, where the interaction with pension freedoms can be complex but where choices can make a huge difference in the results for individuals. But then, I suppose there’s no money in helping with those choices.
Sorry, to be clear my comment was about
the Peoples Pension report
I’m not yet drawing from my pensions which include a DB and DC scheme. The DC workplace pension is the smaller of the two and has a built-in ‘Lifestage Approach’ which starts moving my money into lower risk investments 10 years prior to my chosen retirement age.
Although I intend to retire in the next 12 months (aged 55), I changed my DC pension retirement age from 65 to 70. This will keep my money invested (medium risk) for a longer period of time.
From what I’ve read this could be beneficial?
The trouble with much of this is that life is quite unpredictable.
Many of those for whom life is more predictable have great difficulty knowing when they might retire and what that retirement might look like, especially if it is a few years away. When it comes to it, retirement is often a gradual process involving part time working.
However, for very many people, retirement is driven by unforeseen and unwelcome events. There are first the redundancies, with the uncertainty of what (if any) work can realistically be done afterwards. There are then the health issues which often stop or limit the work that people can do, and indeed the things they may be able to do after work. And then there are the family issues like separation or caring for others. All these are the practical things that drive “retirement” for many and their access to their pensions and state benefits.
At least for most people, it is difficult to see how personalisation can work with any reliability at all. It can’t change how money has been invested in the past. For the future, the small percentage of financially sophisticated and organised people may continually feed changes of personal circumstances to a pension provider. However, this is pure fantasy land as far as most of the “pension lumpen” are concerned. They don’t keep on top of a number of complex things in their lives and have little if any understanding of investment issues. They just understand cash.
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