I frequently get asked about the suitability of certain pensions and about the phased retirement journey… it’s become increasingly common to slowly step away from work and/or to take a [well-earned] break before resuming an occupation. In a nutshell, retirement is less definite.

This demand for flexibility and transparency was a factor in the ‘2015 pensions freedoms’ legislation and the sea-change in pension planning thereafter - an annuity purchase is no longer the guaranteed destination for private pension holders with defined contribution (“money purchase”) schemes, and as a result, numerous legacy policies have become unsuitable.    

A key consideration is the use of ‘Lifestyling’, also referred to as “Phasing” or “Default Switching”. In this scenario, a pension provider will de-risk the assets in a policy as the holder approaches their Normal Retirement Age (NRA); selling down equities and replacing them with lower volatility assets, such as government bonds. By doing so, capital is protected, timing-risk is reduced, and a closer relationship is forged between the assets in the pension and the factors determining annuity prices. This is therefore effective for those that have the “correct” NRA, wish to purchase an annuity (buying guaranteed income for life) and are in good health.  

However, many people select their retirement age at the outset of a policy – typically choosing 60, 65 or State Retirement Age - and life’s journey evolves throughout the accrual process, along with an individual’s plans and priorities. As soon as a shift in the retirement plan presents – early retirement or a desire/need to work on -, a fund which incorporates ‘Lifestyling’ becomes inefficient; there is either more risk exposure than intended or too little. Risk and return are inherently linked. I have reviewed pensions in which assets have been sold down to cash in preparation for the NRA, the pension annual management charges have remained in place (despite the reduction in ongoing management following the exit from the markets)and the resulting performance has been a compounded negative number over the period between NRA (60 or 65) and actual retirement. Minus 2% on minus 2% on …-2%.

This is a prime example of a legacy retirement date, combined with no financial advice, costing a hard-working, careful investor. It’s the nature of a “Default” fund that it will sell-down to cash assets without consultation, and without analysis of client circumstance, market conditions or tax regulations.

Due to the tax treatment of Pensions – they usually sit outside of the estate on death –, retaining their value and utilising other income or capital sources may be efficient for Inheritance Tax (IHT) planning purposes.  

You would not wish to leave an uncrystallised pension in low-risk cash assets over the long-term, exposed to inflation risk and the opportunity cost of being out of the markets.

Furthermore, annuity purchases utilise the entire pension fund (a 25% tax-free sum may be withdrawn) to buy an income. This provides certainty, great, but may inhibit the spouse and/or beneficiaries, and may prove to be low value. A typical open market annuity will pay out at 5-6% -taking c. 17 years to repay the purchase -, whilst investment into the FTSE-100could generate a similar annual return (5.4% average over past 10 years)without the erosion of capital, and with the entire residual fund available to beneficiaries on death of the policyholder. Of course, discipline is required if you are to access monies flexibly (Flexi-access Drawdown (FAD)).

Retirement can be [very] long and monies will be required at the end, as well as at the start. This is a key consideration when individuals consider their retirement strategy and the return profiles they seek.  

This editorial ‘skims the surface’, so there is much to think about in this area of pension provision and an Independent Financial Adviser (IFA) will be happy to help you navigate the choppy waters – I needed a tenuous link to the graphic.

Rob Cowsill, IFA @ SW Financial Planning

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