Savers with lifestyle pension funds may ‘sleepwalk’ into selling bonds

Investors with retirement savings in lifestyle funds that automatically transfer them into bonds have been warned to reconsider because faster-than-expected interest rate hikes will affect their value.

The value of so-called lifestyle funds fell 13% in the two months to mid-February as persistently high inflation and rising interest rate expectations bite, worsening the situation hundreds of thousands of workers.

As people approach retirement, lifestyle funds automatically transfer retirement savings to assets, another fund or funds, which generally have a lower risk profile.

The funds tend to invest in long-term government and corporate bonds, generally seen as a safer haven that protects against stock market downturns and can protect against swings in annuity rates.

High inflation and rising interest rates mean the value of lifestyle funds has fallen in recent months and AJ Bell warns it could get worse

Annuity rates are determined by bond yields, which move in the opposite direction to bond prices.

This means that bonds can be a good option for investors looking to buy an annuity with their pension, as any decline in annuity rates could be offset by an increase in the value of the lifestyle fund.

If bond yields increase and the value of the fund decreases, annuity rates should increase and thus maintain the level of retirement income.

Bonds have generally been seen as less volatile than stocks, but prices are high and yields are very low, and long-term bonds have sold off sharply due to rising inflation and interest rates .

According to AJ Bell, approximately 850,000 pension savers are invested in this type of fund, but for many savers they are no longer suitable for their purpose, as they do not continue to purchase an annuity with their pension pot.

Since retirement freedoms were introduced in 2015, fewer people are buying an annuity instead of choosing to keep it invested for retirement income. This has led to the suggestion that investors should hold onto more stock market investments which can produce a better chance of growth or dividend income.

“The logic behind lifestyle funds is that if they fall in value, annuity rates will rise to compensate.

“But it’s little comfort if you’re not going to buy an annuity with your pension,” says Laith Khalaf, head of investment analysis at AJ Bell.

He added: “Lifestyle funds are a relic of a bygone era when pension rules basically meant that 90% of people bought an annuity in retirement.

“But these strategies are still used today, when only 10% of people buy an annuity.

“Default retirement strategies that might have been in place decades ago are only now beginning to tip retirement investors towards these outdated funds.”

Lifestyle funds tend to be used in older workplace pension plans run by insurers and individual stakeholder pension plans.

While many retirement providers have updated their investment strategies to reflect the small number of people buying annuities, some people may be invested in these annuity hedge funds without knowing it.

As such, Khalaf warns “they could be sleepwalking into a bond market sell-off.”

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, adds: “These funds date from a time when annuities were the retirement income product of choice – the automatic switch from stocks to bonds and cash was designed with the purchase of annuities as the end point.

“However, times have changed and more and more people are looking to stay invested in the market for longer and may need an alternative solution.”

What should those approaching retirement do?

Savers should check if an automatic transfer takes place on their current pension plan and see if it suits them.

The funds will generally be referred to as “long gilt” or “long corporate bond” and will invest in long-term government or corporate bonds.

Morrissey says: “In recent years, providers have sought to address this issue by changing the lifestyle so that it targets declining income rather than an annuity for new customers. However, if you’ve had a pension for a while, it’s unlikely this has happened, so it’s worth checking.

Khalaf explains what investors approaching retirement should consider when it comes to lifestyle funds.

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“Those considering buying an annuity might consider sticking to their lifestyle strategy as it should hedge movements in annuity rates.

“In a rising interest rate environment, they might be better off switching to cash or low-risk multi-asset funds, but that doesn’t protect them if interest rates and bond yields fall again.”

“It seems unlikely, but it is possible and could be triggered by a resurgence of the pandemic, or conflict in Ukraine, or an unforeseen catalyst that derails the global economic recovery.

“Those who plan to invest their pension for income could consider gradually turning their pension pot into income-generating funds, such as multi-asset income funds and equity income funds, which then provide the required amount income needed for retirement.

“Those looking to grow their pension and realize capital gains might consider holding growth funds in their portfolio and simply pursuing this investment strategy until their retirement date.

“This is a riskier approach and likely to be favored by those with high levels of retirement savings, perhaps in the form of a defined benefit plan, or assets such as property, or simply a large defined contribution pension, or a combination of all of these”. these.

“In the three cases above, investors could also consider gradually building up a pool of 25% of the value of their pension, if they intend to withdraw all of their tax-free capital in retirement.

“Those considering taking their pension in cash might consider gradually selling the market and switching to cash as they approach retirement, to avoid any drop in the value of their pot as they prepare to retire. tap into it.

“That puts them at risk of inflation, but it really stems from the decision to cash in the pension, rather than continuing to invest it for the long term, which could provide some inflation protection.”

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