Jelf's Mark Winstanley argues that the Budget changes did not destroy lifestyle strategies, and predicts there will be three predominant paths of member decision-making at retirement, in the latest edition of Informed Comment.
Discussions have since moved on and one of the main topics now is in relation to what will be a suitable default investment strategy. Is this the end of traditional default investment strategies like lifestyle and target date funds?
Traditional lifestyle strategies investing in long-dated bonds could result in a loss of capital if their yields rise
We first need to understand what we mean when we refer to lifestyle or target date funds. Lifestyle strategies, and target date funds, are investment strategies where a member's funds are moved into better matching investments as the member approaches the point at which they are going to draw their benefits.
Traditionally, the majority of UK defined contribution pension scheme members have taken the maximum 25 per cent tax-free cash sum and used the balance of their fund to purchase an annuity. Some individuals with larger pots have instead utilised income drawdown rather than annuitising.
To reduce the annuity conversion risk, lifestyle strategies have automatically switched members out of predominantly growth assets into long-dated bonds and cash in a five to 10-year period before retiring.
Given the Budget announcement, is this still suitable? Without seeing what the full legislation might say, my initial thoughts are that we will have three types of member at retirement:
Those still wishing to annuitise and have a guaranteed income in retirement.
Those with larger pots who wish to do income drawdown over the longer term, maybe five years and longer.
Those who wish to draw cash over the shorter term, maybe fewer than five years.
There will always be a grey area around when the shorter-term cases become longer-term cases.
For those wishing to annuitise I do not see why traditional lifestyle or target date funds do not still remain valid. However, I would hope that the market continues to look at developing more efficient annuity-matching solutions and does not decide it is not worth devoting time to improve the solution for what is likely to be a diminishing population.
For those who wish to use long-term income drawdown, nothing really changes as the traditional default lifestyle was never suitable and there is a need for early engagement before any switching or glidepath period commences.
Tax planning
It is also more important to consider the tax planning aspects of decumulation through this method as the proposals would allow unlimited drawdown in any one year but with any income outside of the tax-free cash sum taxed as earned income.
The interesting group of individuals is those who wish to draw all their benefits immediately or over a short period of time. Traditional lifestyle strategies investing in long-dated bonds could result in a loss of capital if their yields rise, which would not be ideal if they wish to draw their funds as cash.
Therefore, a potential solution would be one in which members are 'lifestyled', but into funds that preserve capital rather than into bonds.
An interesting development we have seen recently was the launch of an annuity-matching fund that also has downside protection in case of an increase in long-term yields.
This could be ideal for those members who will not know what their plans are until closer to retirement but are likely to fall into group one or three.
Lifestyle strategies will still play an important role in the future. However, more than ever we will need to better inform and educate the workforce.
Retirement guidance will need to start at an even earlier age in case members start to look at drawing benefits at an earlier age, maybe to fund that Lamborghini.
You have to ask if the guidance guarantee will be sufficient to influence such behaviour, if this starts and ends when the decision to take benefits has already been made.
Mark Winstanley is corporate pensions director at Jelf Employee Benefits
