Retirement investment decisions need to be made earlier and more often

The big-bang approach to pensions, where you had no choice at 65 other than to collect your gold watch and buy an annuity, is long gone. People are living longer, retirement-age rules are changing and pension products are too.

As a result of this, retirement investment decisions need to be made earlier, more often and long after you retire. Central to this are lifestyling strategies which taper your risk to suit your age and circumstances.

When contributing to a pension scheme, a lifestyle fund is often the default investment option. “A lifestyle fund works great if you are going to buy an annuity because towards the end it will move you towards risk-free cash or low-risk bonds. But [as] 10-year bonds are showing negative returns and banks are charging for deposits, buying power is shrinking,” says Suzanne Cashin of Brewin Dolphin, a wealth manager.

With an annuity rate of 3 per cent you will get €3,000 back for every €100,000 in your fund. “At that rate you are going to have to live 30 years to get your capital back, and that’s a level annuity where if you die prematurely the company keeps your capital,” she says.

It’s part of the reason that more and more people are looking at approved retirement funds (ARFs). “There is still a place for the annuity but the big advantage of an ARF is that the annuity will still be on the table later on if you change your mind,” Cashin adds.

In some cases clients of hers have come back at a later stage, sometimes in ill health and planning to go into a nursing home, at which stage their ARF can be used to buy an annuity. “But if you buy an annuity at today’s low rate, you no longer have that choice,” she says.

Consider your options

If you are thinking about going the ARF route and you are in a lifestyle pension fund, you need to start considering your options, possibly choosing to stay in a higher-risk equities-based fund, at least 10 years before retirement. “Otherwise you will be automatically put into a low-risk investment,” she cautions.

But ARFs are not risk-free. At the very least they may require you to draw down more than 4 per cent of your gross value each year. That can put you at risk of going through your capital prematurely, unless you adopt a certain degree of risk in your investment strategy. The problem is this can feel counterintuitive when you are older and your earning capacity is diminished, if not gone.

“Be mindful that if you are going into an ARF you need to not be risk-averse. A degree of risk is required, to ensure it performs at the rate you need it to,” says Cashin.

People retiring at about 60 can reasonably expect to plan for another three decades, so the horizons are long in investment terms, which is good. Also on the plus side, your ARF does not die when you die, so whatever is left in it can go to your spouse, or your children. “It makes the pension fund a real, tangible asset,” she says.

When ARFs were first introduced, they tended to be the domain of the better off, says Jonathan Daly of Zurich. In the two decades since then, that has changed dramatically. Today 80 per cent of retirees opt for ARFs, with those opting for annuities often doing so in order to avail of the tax-free cash element for a specified purpose.

“Annuity rates are so low now that they seem bad value to people but they do give you certainty,” he points out. “With an annuity, you know you will get a guaranteed income for life, no matter how long you live, and you don’t have to worry about investment decisions again. But still, less than 20 per cent of people go that route now.”

Pros and cons

ARFs come with both pros and cons too, however, the main risk being they could run out of money.

That’s why Zurich has in recent years introduced an ARF that has a lifestyling strategy option built in. With it, once you hit 75, it moves you into cash over an extended period. It also helps guard against the possibility that, at a later stage, you may not be in a position to manage your investments.

“Having a lifestyling element in our ARFs helps take some of the research out of it. With one product you get various options, including automatic derisking, without having to worry about it,” says Daly.

Over the past 20 years investment returns have been good but that may not be the case over the next 20 years, which is why it is important to review your pension regularly and take advice, he points out.

“For most people their pension is the biggest amount of money they’ve ever had to take a decision about,” says Daly.

“Some will have other income sources, maybe a defined benefit from earlier in their career, and the State pension. Very few people will depend on their ARF alone. But while lifestyling strategies can take some of the worry out of it, it’s important to talk to your financial adviser.”