They have been slammed as ‘weapons of wealth destruction’ and they could be silently wrecking your retirement – without you even realising.
So-called ‘lifestyle’ funds are a common feature in workplace pensions.
They are meant to protect the pension pots of millions of workers from the ups and downs of the stock market as they approach retirement age.
But, rather than shielding people from losses and securing them a more prosperous old age, experts say precisely the opposite is happening.
Savers who put into lifestyle funds are ending up with much lower pensions than they could have achieved without taking undue risks on their investments.
The damage is being done right under the noses of millions of middle-aged Britons, whose pension savings are being eroded without their knowledge – let alone consent.
The idea behind ‘lifestyle’ funds makes sense in theory.
They are meant to ensure that their nest eggs built up over decades of toil don’t suddenly vanish if the stock market crashes just at the point when workers retire and take their pension, leaving them permanently worse off.
Lifestyle funds have been slammed as ‘weapons of wealth destruction’
Former pensions minister Ros Altmann sees these funds as unsuitable for many
But far from giving peace of mind, these ‘lifestyle’ strategies – which have been adopted by the vast majority of workplace pension schemes – are virtually guaranteed to lose money in real terms after accounting for inflation.
So how do you know if you are affected? And what can be done to prevent this hidden danger lurking in your pension from ruining your golden years?
Am I affected?
The first thing to say is that if you are lucky enough to be a member of a ‘defined benefit’ scheme, where your pension is linked to your salary, you are not affected and can breathe a sigh of relief. If you are employed directly in the public sector, you are likely to be in a scheme of this sort.
But if you have a ‘defined contribution’ plan where your savings are invested in a pot of shares and other assets, then you may well be shunted into a ‘lifestyle’ fund in your fifties. Most employees in the private sector are in plans of this sort.
So what is a lifestyle fund?
Pension funds invest in a range of assets including shares, bonds and property. These assets carry varying degrees of risk and reward.
The concept of ‘lifestyle’ funds is that, as people draw near to retirement age, their pension nest-egg is moved into cash and bonds. The latter are essentially IOUs issued by companies and governments.
Putting savings into a lifestyle fund is meant to ensure they are insulated from the vagaries of the stock market and that savers don’t incur heavy losses just as they approach retirement.
Lifestyle funds confusingly might also be called something else, such as a ‘target date’ fund.
Am I in one?
You are not alone in not knowing. Three quarters of pension savers have never heard of ‘lifestyling’, recent research from RBC Brewin Dolphin revealed.
Some 64 per cent are unaware that their savings will be put into such a fund unless they take active steps to avoid it.
If you are within ten years or less of your intended retirement age and you are saving in a defined contribution scheme then you may well be in a lifestyle fund.
If you are in a defined benefit scheme – most public sector workers are – then don’t worry, it does not apply to you.
Many private sector workplace schemes switch members into lifestyle funds within six to ten years of their intended retirement date.
This is usually the State Pension age, which today is 66. The switch to lifestyling normally happens automatically, without your consent.
The lifestyle fund will be managed by an investment firm selected by your employer.
These include household names such as Legal & General, Aviva, Scottish Widows and Nest, which alone has 13million lifestyle fund members.
You can opt out – but the onus is on you to do so.
OK but why is this a bad thing?
Because the returns on lifestyle funds are much lower than those savers might reasonably expect to obtain elsewhere, without taking undue levels of risk.
Lifestyle funds invest in cash and in bonds – which misleadingly are often portrayed as ultra-safe. This type of fund is likely to make low or even negative returns once inflation is taken into account. In other words, savers are missing out on potentially better opportunities and likely to lose money in real terms.
Once the era of ultra-low interest rates ended in 2021, bond prices began to fall – and the shortcomings of lifestyle funds were cruelly exposed.
UK government gilts in particular have been lousy performers as the cost of borrowing soared to tame runaway inflation.
This has spelt disaster for those approaching retirement with their savings in lifestyle funds – usually without their knowledge.
To rub salt into their wounds, stock markets have boomed in recent years – especially in the US – meaning they have missed out on the opportunity to make much more for their golden years.
The net result is that those planning to retire have a lot less in their pension pot than if they had stayed invested in shares.
So how much worse off are we talking?
You’re not going to like this. Adam Walkom, a financial planner at Permanent Wealth Partners says ‘lifestyling’ is ‘absolutely a weapon of wealth destruction’.
As he points out, although cash and bonds are meant to be safe investments, savers are actually locking into losses once inflation is factored in.
‘If you end up in just cash and bonds you’re not going to get your money back’ in real terms after taking account of inflation, he says.
Exclusive research for the Mail reveals a pension pot that had been automatically lifestyled over the last 14 years and is worth £100,000 today would have been worth £135,600 if it had been invested in growth assets such as shares since 2010.
This gap grows to over £61,000 if the money had been invested since 2000.
‘Lifestyling is now a proven failure over a quarter of a century,’ says Henry Tapper of AgeWage, a fintech firm that carried out the survey of 3,000 adults with pensions consultancy Hymans Robertson.
‘It is not fit for purpose and a hangover of the actuarial culture that has dominated pensions for 50 years.
‘Lifestyling is generally a value destroyer for what people want: the biggest pension pot possible.’
In extreme cases, the results have been disastrous.
Walkom cites the case of Martin, a 59-year-old man who was forced to retire early because of a disability.
His biggest pension pot, built up with a former employer, was worth almost £200,000 in June 2021.
But by October 2023 it had shrunk to just £134,000 because Martin’s pension had been steadily ‘lifestyled’ into a gilt fund whose price crashed in the wake of the Liz Truss mini-Budget.
Are there any plus points to lifestyle funds?
Yes. Sonia Kataora, a partner at pensions firm Barnett Waddingham says there are pros as well as cons.
With a lifestyle fund you don’t need to manage your investments, it is all done for you. You are also protected against sudden stock market sell-offs.
Lifestyle funds work best if you plan to buy an annuity – a fixed income – at a set retirement date.
Annuity rates – which determine how much annual fixed income you receive – have increased in recent years as interest rates have risen.
That means the cost of securing the same annual income has fallen.
Put another way, if a lifestyle fund’s value drops it still secures the same future benefit because it has become cheaper to buy an annuity.
If you decide against lifestyling and choose your own investments, you risk making mistakes. Plus, it requires time and effort. There is also the potential for rash decisions that could undermine your long-term goals. But the upside is that you could receive much better returns than through lifestyling.
It’s crazy. How did this come about?
Good question. Lifestyle funds are the relic of a past system under which they did make more sense.
Until 2011, any member of a pension scheme had to buy an annuity – a fixed income for life – by the age of 75.
Under that system, when people had a ‘target date’ for taking their pension, there was indeed a rationale to move into less volatile investments as retirement beckoned.
However, there is now no requirement to buy an annuity. Increasingly, people don’t set a cliff-edge retirement date but work part time or flexibly as they get older and ease their way out, often opting not to take their pension all at once.
Rather than locking themselves into an annuity in a one-off, irrevocable move, people can draw down an income from their pension pot according to their needs and what they can afford.
With increasing life expectancies, someone in their fifties may have another thirty or more years to live. Over that time horizon, history tells us shares will deliver better significantly returns and protection against inflation than bonds or cash.
‘The lifestyle and target-date default funds are not suitable for many people,’ says former pensions minister Ros Altmann.
‘Workers are unknowingly having their money put into investments that will usually give much lower returns,’ she adds.
‘Lifestyle funds should have been re-designed when pension freedom reforms came in more than a decade ago.
‘But that didn’t happen and the industry has just kept on doing the same old same old thing,’ she laments.
Shouldn’t they be doing something now?
You’d think – but the wheels move slowly in the pensions world.
The Financial Conduct Authority (FCA), the industry regulator, is on the case.
‘Pots at retirement are smaller than they otherwise would be, with some savers stuck in under-performing default [funds] for a sustained period of time,’ said Sarah Pritchard, the FCA’s markets director as she launched a ‘value for money’ review earlier this year.
Don’t hold your breath.
What can I do?
If you are in your fifties or above, check your workplace pension to see if you have been switched into a lifestyle fund or if you will be in future.
Most will have a website where you can see which funds you are in, and how those funds invest your money.
The sooner you act the better because the closer to retirement you are, the less time you have on your side. If you still have several years to go before you plan to give up work, then there may be scope to make up for at least some poor performance in your pension due to ‘lifestyling.’
It is a good idea in any case to check regularly on how much you and your employer are paying into your pension and on the performance of your plan.
‘Having some idea about retirement plans and how income will be produced is essential as we enter our fifties,’ says Rob Burgeman, senior investment manager at wealth manager RBC Brewin Dolphin.
As you get older, it does make sense to take fewer risks with your pension pot, so it’s important not to veer from one extreme to another and shift into highly speculative assets.
If your pension is less than you hoped but you are still some years away from retiring, you could increase your contributions if you can afford it.
Another option, if you are able to, is setting a later retirement date.
You can decline to have your savings put in a lifestyle fund in the first place if you act in time. You can also switch your savings out of a lifestyle fund into one that invests in shares in the hope of better performance, although this is not guaranteed and you might lose money.
Employer pensions will offer a range of funds to choose from.
You may be able to switch between funds yourself online on the scheme website. If that is not the case, you can ask your workplace pension provider to move your pension into a fund or funds that you prefer.
Choosing your own fund can be daunting, so it may be worth paying to see a regulated financial adviser who can assess the options for you. Given the sums at stake, that may prove the best investment of all.