Pension savers could unwittingly lose out on tens or even hundreds of thousands of pounds if they allow their fund to be "lifestyled" in the run-up to retirement, according to new analysis from Murphy Wealth.
Lifestyling is a widespread but little-understood strategy of gradually derisking pensions. Many people with invested "defined contribution" pots are defaulted into it, often without realising, in the decade before their retirement age.
"The approach lifestyle pensions take sounds sensible enough, but the reality is that lifestyle pensions are actually far riskier than you initially think," said Adrian Murphy, chief executive of Murphy Wealth.
Murphy said lifestyling reduces the potential returns on a pension pot at the point when they can make the most difference. "Because your pension fund will be at its largest in the later years, this is when compounding can have the greatest impact. A difference of just a few percentage points in annual returns could mean tens of thousands of pounds," he said.
How lifestyling works
Late in working life, savers in pension schemes typically see their pots shifted out of stock markets and all or part way into bonds, historically regarded as the "safer" option, and cash. The aim is to avoid big losses from a market crash just before retirement.
The approach can suit people who plan to cash out or want to maximise a fund to buy an annuity to pay for old age, but it can backfire for long-term investors. Holding a mix of cash and government and corporate bonds, which typically produce lower growth than stocks, is not advisable for anyone planning to stay invested in the stock market and keep growing their pension through retirement.
Murphy pointed to 2022 as a cautionary tale. Rising interest rates that year saw the value of bonds collapse, leaving a large hole in many retirement plans, particularly for savers in lifestyle strategies that had already begun to derisk. "What was labelled 'low risk,' in fact turned out to be far from it," he said.
Bond markets are in turmoil again after US debt hit $40 trillion, and a market intervention by President Donald Trump's administration has so far failed to halt a bond sell-off.
What lifestyling could cost you
Murphy modelled the impact using the median salary of £29,000 for someone aged 22 to 29 who makes the minimum pension contributions through auto-enrolment, or pays in larger sums. The contribution figures include personal and employer contributions plus tax relief from the government, and assume average wage growth of 3 per cent a year over 40 years.
He compared the returns from staying invested in the final decade before retirement against moving into cash and bonds over that period, assuming growth of 6 per cent for stocks, which he called a relatively conservative estimate, against 2 per cent for bonds and cash under a lifestyling strategy.
For someone contributing £132.80 a month under auto-enrolment, staying invested produced a pot of £395,000 compared with £232,000 if lifestyled, a difference of £163,000. At £250 a month, staying invested produced £492,000 against £279,000 lifestyled, a difference of £213,000. At £500 a month, staying invested produced £984,000 against £558,000 lifestyled, a difference of £426,000.
Should you let your pension be lifestyled?
Murphy said anyone ten or fewer years from the normal retirement age set by their pension scheme should check whether their fund is going through lifestyling, sometimes called derisking or target-dating.
Savers may have received letters about the process without realising its implications, he said, while some pension providers have stopped sending paperwork altogether and instead leave messages on the saver's pension account, which are easily missed by anyone who logs in only occasionally.
Being lifestyled might still suit a saver's plans, for example if they want to avoid big swings in the value of their fund before buying an annuity. The point, Murphy said, is to find out what is happening and then decide whether it matches individual goals for funding retirement.
"If you suspect you are in a lifestyle pension fund, bearing in mind the majority of people likely are, check the date it begins to derisk and carefully consider whether that type of product matches your plans for later life," Murphy said. "The key is to make sure your investment strategy is aligned with how you actually intend to use your wealth."
Millions in default funds
Murphy said the exact number of people enrolled specifically in lifestyle pension funds is not published. But he said the vast majority of the UK's 22 million workplace pension savers are likely to be in default funds, which savers are signed up to unless they actively choose their own investments within a workplace pension. Many of these default funds use a lifestyle approach that automatically shifts investments into safer assets as retirement approaches, he said.
Murphy said other lifestyle pension strategies have begun to emerge that do not fully derisk into cash. Instead, he said, they maintain a blend of lower-risk assets such as short-dated bonds, diversified fixed income, and sometimes infrastructure or defensive equities as savers approach retirement. "But that shift has only been relatively recent, and we won't see most of the people on these schemes approach retirement for some time yet," he said.
