Investment choices in the run up to retirement used to be simple, with most people opting for low risk options to match the annuity they bought to generate an income. But the introduction of greater choice and flexibility means this may no longer be the most appropriate option for many people.
Since April 2015, retirees have had much more flexibility around how they take an income from their pension. As well as an annuity, these include taking an adjustable income through flexi access drawdown; taking cash withdrawals, potentially even the whole pot, when it suits them; and even leaving their pension untouched to pass on to family or friends.
It's also possible to mix and match these options to suit income requirements and attitudes to risk. As an example, while it's become much less popular for an annuity to be the only vehicle for retirement income now there is more freedom and choice, we've seen more people considering using part of their pension pot to buy an annuity that covers their core living expenses. Once they've secured the guaranteed income an annuity offers, to take care of these expenses, they can then leave the remainder of their pension pot in drawdown. This gives them the benefit of security but also the flexibility to top their income up or withdraw a lump sum to cover ad hoc expenses.
Unfortunately, although people now have much more choice around how they take their pension, the investment strategies on offer in the run up to retirement haven't necessarily kept pace. Instead many pension providers continue to offer a life styling approach. With this, as someone approaches retirement, they shift more and more of their pension into low risk investments such as gilts, fixed interest and cash to protect the pot from a stock market tumble.
While this is great if someone is planning to take out an annuity or cash in their fund at retirement, it's not the best approach for people wishing to leave their pension invested or go into drawdown. In these instances, providing they're planning to leave the money untouched for five years or longer, taking more risk with their investments can offer them the opportunity for growth.
As an example, someone has a retirement age of 60 but is delaying taking out an annuity to access their pension as they intend to keep working until they're 70. However, as they selected the lifestyle option when they joined the scheme, their pension was transferred into low risk investments in the five years before they reached 60. This means they miss out on 10 years in higher risk stock market investments, potentially leaving them with a smaller pension pot.
New flexible approach
With so much flexibility available, it's important to reflect this in the investment choices available on a pension.
Target date funds are an option worth considering. These are multi-asset funds where the manager controls the asset allocation as the target date approaches. Unlike a lifestyle option that stops dead at a given date, these funds typically have a three or five year 'vintage' with members selecting one that broadly matches their planned retirement date.
While they benefit from a lower risk strategy as they get closer to taking their pension, they also remain invested so there's more opportunity for growth. It's also possible to switch between funds, opting for a different vintage if retirement plans change.
As well as offering more appropriate investment choices to employees in the run up to retirement, it's also important to consider the transaction charges they might encounter with today's more flexible retirement options. These vary and can depend on the level and type of activity.
Given this, and the variety of options available to people approaching retirement, it's sensible to offer access to modelling tools. These allow them to weigh up different retirement scenarios so they can understand the parameters and plan ahead.
For example, an employee wishing to go into flexible drawdown could use these tools to model the effect on their pension pot of taking different income levels. This would enable them to see what would be sustainable and the type of investment return they would need to achieve on their pension pot.
Similarly, they could also use these tools to assess the level of income they could expect from an annuity. This might help them decide whether an annuity, drawdown, or a combination of the two is the most appropriate option to fund their retirement. With so much more flexibility and choice around taking your pension at retirement, it's essential that employees are able to take full advantage of these options. Giving them access to a platform that offers appropriate investment choices, competitive transaction charges and modelling tools will enable them to make the most of their retirement.