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The pension oversight that could cost you £1,000s

Written by: Paloma Kubiak
It’s important to check the target retirement age you selected when you started your pension. If it’s too early, you could miss out on thousands of pounds in returns over the years.

When you start to save into a pension scheme (workplace pension or private pension), you can select a target retirement age, which is commonly 60 or 65.

However as life expectancy continues to rise, you may find you actually selected an earlier-than-expected retirement date.

This small pension oversight can have significant implications for your retirement income. This is because the funds you’re invested in will start to de-risk sooner than you need – in other words, move into what are considered less risky asset classes. Some pension experts estimate this could cost you between £20,000 and £100,000 in returns.

Below we explain in detail why this happens, who it affects, how much it could potentially cost you and how you can rectify the situation.

Default funds with ‘lifestyling’

Pension schemes tend to have a default fund in place which offers an appropriate investment strategy for people who can’t or don’t want to make their own investment decisions.

These lifestyle or default funds tend to de-risk during a period known as the investor flight path, or glide path, when the pension saver approaches their selected retirement age.

De-risking tends to take place between five and 15 years (it varies between pension schemes) before your target date as recorded on your pension papers.

It essentially means the fund increases investment exposure to less risky assets such as bonds and cash and decreases exposure to riskier assets such as equities. By moving to more cautious investments, there’s less risk that savings will fall sharply right before retirement when there isn’t enough time to make up any shortfall.

Workplace schemes used for auto-enrolment have to have a default fund and with about 7.5 million people auto-enrolled, 80% of these people are in the default fund. Other defined contribution (DC) pension schemes may offer a default fund but there’s no requirement to do so. And people who’ve also actively selected a lifestyle fund may also be affected.

Rising retirement age

The vast majority of people do not retire when they originally expected to do so. Research from Aegon’s Readiness Survey last year revealed that less than a third (28%) of people retire on the date they actually planned to. Of course, some retire sooner due to ill health or redundancy, but Aegon says that increasingly, many more people retire later.

A target retirement date of 60 specified many years ago may now be unrealistic, while a target age of 65 can also be too early for some people who may be in good health and want to continue working into later life.

Kate Smith, head of pensions at Aegon, says this issue does not just affect those who are in their 50s and 60s who are due to enter their pension de-risk strategy, as it will affect anyone in their scheme’s default fund.

Smith says: “People should check what funds they are investing in, when they want to retire, how they want to take their retirement income, such as an annuity, income drawdown, guarantee or cash, and how far in advance they want to start de-risking.

“If you’re in a lifestyle fund, find out when the fund starts to de-risk, and what the fund’s objectives are. Circumstances change, so it’s important that people review their investment choices to make sure they meet their needs. A choice made at the age of 35 may not be appropriate for someone at 55.

“People need to be realistic about the age they will retire at. People tend to retire much later and keep on working later into life. For workplace pensions, the pension retirement age tends to be 65 nowadays. But this is often an arbitrary age as most people don’t tend to retire at the age they originally thought they would.”

Smith confirms the onus is on the individual to review their retirement age. Pension providers issue annual benefit statements, which include the individual’s selected retirement age and details of the investment funds. They will also warn when the funds are close to starting to de-risk, which she says should prompt people to carry out a review of their pension.

She adds that it’s easy enough to change your target retirement age, but for those in a default or lifestyle fund they should try to do this earlier, before it starts to de-risk.

How much could this cost you?

Estimates from Hargreaves Lansdown reveal a fund de-risking too early could mean a difference of £20,000. It gives the following scenarios to illustrate the point based on an investor with a £100,000 pension pot at the age of 55 who will access their pension pot at the age of 65 (based on a 5% net return for the ‘growth’ fund and 2% net return on the ‘de-risking’ fund):

  • De-risking starts at age 55 from a ‘growth’ fund to a ‘de-risking’ fund. So the investor is 100% invested in the de-risking fund at age 60.
  • De-risking starts at age 60 from the ‘growth’ fund to the ‘de-risking’ fund. So the investor is only 100% in the de-risking fund at age 65.

The difference between the two strategies is that de-risking starting at age 60 gives a higher overall pension pot of £20,154. This is because the lower returns of the de-risking fund act as a drag on performance for longer in the first scenario.

Pension Pot at 65
De-risking begins at 55 £129,219
De-risking begins at 60 £149,373

Nathan Long, senior pension analyst at Hargreaves Lansdown, says: ‘Keeping an eye on your pension’s retirement age is crucial as it is often the trigger for when investments begin moving from the more adventurous to the more conservative. If this de-risking happens too early you can really harm your prospects of a plentiful pension pot. It is well known that we are living and working longer, so this is just another reminder that taking control of your own pension plans is the number one route to a comfortable retirement.”

AJ Bell has also provided an illustration of the potential losses in de-risking too early. It has assumed three different growth rates on £100,000 invested at the age of 30:

  • Equities – 5% return
  • 50:50 Equity:Bond – 3% return
  • Bonds – 1% return

It also looked at these two scenarios:

  1. De-risking starts 10 years before stated retirement age of 60 (ie age 50)
  2. De-risking starts 10 years before actual retirement age of 67 (ie age 57)

Both portfolios are invested in equities until they start de-risking and then move from equities to 50:50 equity: bonds for the first five years and then to bonds for the rest of the period.

The fund is worth £333,396 at age 67 if de-risking kicks in at age 50, but it is worth £437,559 at age 67 if de-risking starts at age 57.

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