DC Default Lifestyle Strategy Update

The challenge

A DC pension fund had a default lifestyle strategy that targeted the purchase of an annuity at retirement. Since pensions freedoms were introduced in 2015, sales of annuities have plummeted as more attractive options are available.

We conducted a member preference survey, which showed varying retirement needs with the majority of members preferring to target income drawdown and a tax free cash lump sum in retirement versus annuity purchase and tax free cash.

The default life-style option should be designed with the likely membership profile in mind and follow the standards set out by the Department of Work and Pensions. Specifically, it should consider the likely characteristics and needs of employees who will be automatically enrolled into it.

The default investment strategy and associated life-style glide path was changed to target income drawdown in retirement, whilst still assuming that members would take the 25% maximum tax free cash lump sum.

The solution

Our approach to asset allocation starts with the ultimate objective, which primarily revolved around the retirement outcome targeted.

  • The appropriate level for risk and the expected return was first decided upon. We then derived the strategic asset allocation. This was obtained for each stage of the life-style glide path. A stochastic model was used to decide upon the most efficient asset allocation from a risk and return perspective.
  • We then identified suitable investment funds to implement the strategy. Broadstone’s investment manager research team cover all asset classes including diversified strategies and multi-asset funds. Following extensive research and taking into consideration a number of key criteria (including performance, volatility and fees) a multi-asset fund was chosen for the pre-retirement accumulation phase to provide diversification and manage downside volatility whilst also providing a level of expected return comparable to equity markets.
  • As members approach retirement, their holdings are switched into lower risk diversified strategies and cash that can be relied upon to provide income in retirement, and an initial tax free cash lump sum.

The outcome

The default investment strategy and associated life-style glide path was changed to better meet the investment preferences of members whilst still offering a strong risk and return profile falling within the charge cap.

Targeting income drawdown in retirement allows members to remain invested following retirement and continue to earn investment returns above inflation, which protects buying power as prices rise.

Investing in diversified strategies which put an increasing focus on income producing assets – as members approach retirement – allows members to target a sufficient level of investment return whilst providing a necessary level of downside risk protection.

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