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Yesterday’s solutions won’t necessarily solve tomorrow’s problems

Reprofiling pension risk can make significant differences as people approach retirement

When it comes to pensions, lifestyle is more than about a beach and an airport blockbuster. It’s also a strategy for de-risking people’s pensions savings as they approach retirement. The theory is that as people near the end of their careers there is less time for their pension pots to recover from short-term market shocks and there is a gradual shift in the balance of their investments away from risk assets such as equities and into low- or even no-risk assets such as cash and government bonds.

It is difficult to argue with a safety-first approach like that, but is it still appropriate today?

"Historically people were building a pension pot so that at retirement they could buy an annuity which provided fixed income in retirement," says Emmet Leahy, head of financial planning with Davy. "In this scenario you definitely want certainty and don't want a market shock the day before retirement, so it made sense to de-risk in the run-up to retirement as lifestyling entails."

In the current low interest and low bond yield climate, the annuity option is still there but very unappealing and expensive, he adds. “The most popular option for retirees is to retire their pot to an approved retirement fund [ARF], which is essentially a tax-sheltered fund from which people will draw an annual income in retirement. Their benefits include flexibility of approach, control over investments and spending, and the ability to pass assets to the next generation, which isn’t possible with an annuity or a defined-benefit pension. But it comes with that need to keep assets invested throughout retirement and bear the investment risk in doing so.”

This significantly changes the investment conversation. “The cash and bonds that a lifestyle strategy may de-risk to are no longer appropriate when the investment horizon may be several decades over your remaining life,” says Leahy. “In fact, this strategy, if taken blindly, can hurt your chance of meeting your retirement goals. While some cash and bonds may be needed for short-term needs, holding too much can really hurt as negative interest rates and inflation may erode the value of your capital over time and you can miss out on the upside in markets needed to deliver the returns you need.”

Pension drawdown

A lifestyling strategy should reflect how the individual intends to draw down their pension benefits, Bank of Ireland head of pensions and investments Bernard Walsh advises. "I go back to the business self-help book Seven Habits of Highly Effective People by Stephen Covey, " he says. "You should begin with the end in mind. Look at what you intend to take in cash and de-risk for that. An ARF will involve continued investment long into the future. Why de-risk into very cautious assets when you have an expectancy of living into your mid-80s if you are 50 years of age? If you start de-risking to age 65, are you going to have to reverse that to go into an ARF?"

He says it may be appropriate to take some risk off the table, but people still have to look at an investment horizon of 20 years post-retirement. “You need your money to grow and, for that, you must take some risk. What’s really important is to understand how you will draw down your pension benefits. It’s important to be on the right train track to deliver the outcome you’re looking for. You also need to pay attention to dates. If you de-risk to draw down your pension at 65 and if the State pension only kicks in at 67 or 68 you could end up with mismatched retirement plans.”

Leahy points to a particular situation where lifestyling may be very appropriate. This applies to those fortunate few who are in danger of exceeding the €2 million funding cap on pension savings. “If someone is approaching the cap they could use a de-risking strategy to avoid getting hit with the large penalties that go hand in hand with a breach.”

Barry McCall

Barry McCall is a contributor to The Irish Times

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