What's wrong with my lifestyle?
By Tom McPhail | 10 Oct, 2008
One of the key risks with money purchase pension arrangements can come at the moment when you convert your accumulated pre-retirement pension fund into a post retirement income (the useful, if inelegant term for this is decumulation).
So, conventional wisdom suggests that the way to manage this transition is to slowly shift your investment holdings from equities to bonds and cash in the last five years or so before retirement. This can be done in a mechanised way, with for example one sixtieth of your fund being switched every month through the course of the last five years. This is often referred to as a ‘lifestyling investment strategy’.
I think this is a good idea if the alternative is simply to go from 100% equities to 100% fixed interest on one day, but the current market conditions highlight the flaw in this plan. Given what the equity markets have done in the past eighteen months, if I were five years from retirement now, I would loath to start switching out now and thereby crystallising my losses. You may decide to take control yourself and decide to switch at any high points rather than on pre determined dates. It might make more sense to hold off for a year or two and adapt one’s plans according to how the markets and your personal circumstances unfold. Alternatively it might make sense to start off retirement using drawdown instead of simply buying an annuity. The point is that there is a variety of solutions available and simply sticking with the tick-box solution may not be the best strategy for you.
If you do opt to use a drawdown plan to pay your retirement income then timing is less of an issue, because you are likely to maintain a significant exposure to equities after retirement. However you are still depleting your fund at a time when its value might be depressed, and therefore you will have less to bounce back, and you will still be exposed to any falls in the future. If you are buying an annuity with your fund, then you are in effect shifting to a wholly fixed interest investment in retirement when equities are at a low point (because annuity rates are set largely by bond yields), but on the other hand it is the insurance company that is then taking the future investment risk and not you.
Equity exposure for most of your pension plan’s life makes sense, as does a gradual de-risking process in the run up to retirement. There are very few automated strategies that can work come what may though, and there is no substitute for making informed decisions to meet your own needs.
