Before the new pension freedoms were introduced in 2015, most people used their pension savings to buy a guaranteed income for life – called an ‘annuity’– from an insurance company.
Recognising that many people would buy an annuity, lots of pensions automatically switched investments into long-dated bonds in the five or ten years before savers’ intended retirement date. This process is commonly referred to as ‘lifestyling’, or ‘lifestyle funds’.
A balancing act
Annuities also invest in long-dated bonds, so by moving savings into similar investments, the chance of investments moving in a different direction from annuity rates was minimised.
If the value of long-dated bonds goes up, annuity rates usually go down.
The fact that this will increase the value of the pension fund means the fund holder would be able to buy broadly the same amount of guaranteed income as they could before.
Similarly, if the value of long-dated bonds falls then annuity rates usually rise, each cancelling out the other.
Does your pension have a lifestyling option?
If your pension already has an annuity lifestyling option, then this could be tailor-made for people buying an annuity. As well as switching most investments into long-dated bonds, some lifestyle funds also switch a quarter of the savings pot into cash, in anticipation that savers will take their maximum tax-free lump sum. However, a word of warning; not all lifestyling funds target the purchase of an annuity. Some, for example, may take a broader approach that is more suitable for those planning to take income withdrawals from their fund or take their whole fund as a lump sum.
If you do plan to buy a guaranteed income for life, check to see whether your pension already has a lifestyling option built in that targets annuity purchase. Alternatively, most pensions have lifestyle funds that you can switch into that target annuity purchase, if a guaranteed income is your preferred choice.
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