"Retirement savers are sleepwalking into a pension disaster"

[dutchman]

More than £15bn in workplace pensions is invested in funds that are 'no longer fit for purpose'



Billions of pounds in pensions are at risk because of rising interest rates, as those nearing retirement have been shoehorned into “outdated” investments.

More than £15bn in workplace pensions from 850,000 workers has been put into funds that automatically shift from stocks to bonds as a saver ages, known as “lifestyling”. Such plans are “no longer fit for purpose”, experts have warned, and will lose money as inflation and interest rates increase.

The average fund has already lost more than 8pc in less than three months, with £1.3bn in hard-earned savings wiped out, according to Laith Khalaf of AJ Bell, a stockbroker. Pension pots will fall further this year as interest rates creep up, he said. Savers approaching retirement must take a look under the bonnet of their pensions and check the investments match their ambitions.

Pensions that shift investments as you age were designed for those who buy an annuity, as the vast majority of savers did before pension freedom rules were introduced in 2015. Now, just 10pc of over-66s opt for the ­guaranteed income.

Until a decade ago, it was compulsory for savers with a workplace pension to buy an annuity or other income plan by age 75.

Mr Khalaf said: “These lifestyling funds were created a long time ago, when nine in 10 people bought ­annuities. But workplace pension providers are still ploughing on and shifting older investors out of stocks and into bonds.”

An estimated £30bn will be switched this year into investments that will likely return less than inflation, he added.

Savers need to own more shares to keep up with rising prices, after inflation hit a 30-year high of 5.4pc in December, he said.

The Bank of England has increased the Bank Rate twice in six weeks, from 0.1pc to 0.5pc. This has spelt trouble for bonds as the cost of ­borrowing rises.

Rob Morgan, of Charles Stanley, a broker, said switching out of stocks too soon would hamper one’s retirement. “If your pension starts gradually switching out of stocks from age 45, as is common in workplace pensions, then you miss out on years of investment growth if you do not access the money until 65,” he said.

DIY investors have relied more on shares to grow pensions and use stock markets and dividends for income. This is because payouts from annuities fell dramatically after 2008 as interest rates fell. Money printing from the Bank of England also pushed up the value of bonds and pushed down yields, which are used to price annuities.

Lifestyle funds have papered over the cracks in the past decade as returns from bonds were fuelled by falling interest rates. A basket of UK Government bonds returned 40pc since 2012. The FTSE 100 rose 90pc in the same period, but with substantially more risk and volatility. Bonds suffer when inflation rises, as they pay a fixed income whose value is eaten away, making them less appealing. The price of existing bonds also falls when interest rates rise, as investors sell them to buy better deals from newly issued debt.

Mr Morgan said lifestyling was not right for the future, as the outlook for inflation and rates had changed. “For people who plan to draw from their pension as and when they want, these funds are counterproductive,” he added.

Lifestyling became common in the 1990s in workplace pensions, both those provided by employers and insurance companies. Mr Khalaf added: “There is still a vast sum of money in these default funds now. Setting an automatic investment strategy that will take place in 20 years is a fool’s errand, because no one knows what changes will happen that may render even the most well-intentioned plans obsolete.”

In 2021, the City watchdog, the Financial Conduct Authority, enforced a new version of default and lifestyle funds called “investment pathways”, which were branded “fundamentally flawed” and “potentially dangerous” by experts at the time. The new system means savers approaching age 55 are asked how they intend to use their money over the next five years if they have not sought professional advice. Their response shoehorns them into one of four investment funds. Savers already older than 55 are not affected.

Mr Khalaf said this would be better for the next generation, but the basic problem still existed. “Savers should not rely on default plans that work on a one-size-fits-all basis,” he added.