Deferring the drawdown date on pensions may help some whose funds evaporated in the crisis, writes Caroline Madden

SINCE THE financial crisis struck, many people have seen a large chunk of their pension fund simply evaporate. In fact, stock market carnage has wiped around 33 per cent off the value of Irish pension funds in the last 12 months.

The investment horizon of most pensions is generally 25 years or longer, and historically equities have delivered higher returns over the longer-term compared to other asset classes such as cash, bonds or property. So for young pension fund members for whom retirement is far off in the future, the drop in the value of their fund in the short term isn't a complete disaster, as it may well have recovered by the time they retire.

But, over the past decade, almost all Irish managed pension funds have failed even to match the rate of inflation.

For members of defined contribution (DC) pension schemes (where the eventual pension is determined by the investment performance of contributions made by the member and/or their employer) who are close to retirement, the situation is grim. They do not have the luxury of time to recover their losses.

Conventional wisdom suggests that a pension fund should be gradually switched out of equities and into more conservative asset classes - such as cash or bonds - as the person come within five to 10 years of retirement. This strategy is known as "life-styling", and is designed to insulate older members from stock market volatility.

However, people currently at this point are in a dilemma. Should they proceed with the move out of equities - crystallising the losses incurred over the past year - or try to wait it out in the hope of recovering some ground and reducing equity exposure much closer to their retirement.

Another group facing major headaches are those people who did not avail of the life-styling option when choosing their pension plans. These people are now nursing major losses. How did this happen?

"The life-styling idea is a relatively simple concept, and not difficult to explain, I would have thought," observes pensions ombudsman Paul Kenny. "The problem really is that an awful lot of people just switch off when it comes to having these things explained to them . . . Their eyes glaze over, and it's no wonder that things do go wrong for people on that account."

The ombudsman has noticed a significant increase in complaints this year from individuals whose pensions have been hit by stock market exposure.

The complaints fall into two categories. Firstly there are individuals who feel that their instructions to switch to safer asset classes were not acted upon. "If I'm certain that their instructions weren't followed, I will award redress against whomever it was who failed to implement their instructions," Kenny says.

In the other category are people who simply didn't know how their pension fund was invested.

"They didn't take any interest in it or didn't feel that they were competent to take an interest in it," Kenny says. For whatever reason, they didn't fill out the scheme questionnaire to indicate what type of fund they would like their pension invested in, so they ended up in the scheme's default option.

Many DC schemes have a managed fund as their default option. These funds tend to have a large equity weighting, and therefore are far from ideal for older members.

A life-styling option is offered as an alternative by most of the main pension providers. If all pension scheme trustees selected this as the default option for their members (rather than a managed fund), far fewer people would now find themselves on the brink of retirement with a sorely depleted pension fund. Kenny agrees that it "might be very prudent" for pension trustees to adopt this approach.

So what is the best course of action for individuals close to retirement who have lost a major chunk of their pension to stock market crashes? Should they switch what remains of their fund into cash and bonds in case markets fall further (and wave goodbye to any chance of ever recovering the loss), or should they take the riskier option of keeping their hand in the stock market in the hope of catching an upswing?

"If they moved into conservative assets, into cash and bonds now, they're crystallising the loss," says Fiona Daly, managing director of Rubicon Investment Consulting. "If they leave it in equities . . . it's kind of a flip of the coin."

Niall O'Callaghan, a personal financial adviser with Mercer, recommends that people investigate whether they can defer the drawdown date of their pension benefits, in order to extend out their investment time horizon and give themselves a better chance of recovering some of their losses.

Some people may be able to buy themselves more time by deferring their retirement by a few years, but some employers operate a mandatory retirement age, so this may not be an option.

The crux of the issue is that members of DC schemes are forced to buy an annuity (a guaranteed annual income) when they retire, whereas self-employed people, company directors holding 5 per cent or more of the company's shares, and individuals with PRSAs have the option of transferring their funds to an approved retirement fund (ARF). This allows them to keep their funds invested in retirement, and draw down on them as the need arises.

If a DC member has made additional voluntary contributions (AVCs) to their pension, these can be used to purchase an ARF, but their main pension fund must be used to buy an annuity on retirement.

"If you don't have time on your side then you're in trouble and that's why I would like to see some relaxation of the requirements to buy annuities," says Kenny. He is supportive of the Irish Association of Pension Fund's (IAPF) call to the Department of Finance to allow members of DC schemes to go down the ARF route, or at least to temporarily defer the purchase of an annuity.

Neither of these courses of action would cost the exchequer anything, according to Jerry Moriarty of the IAPF. In fact, if people were allowed to defer purchasing an annuity until markets recover, the value of their annuity would be higher, which would result in a greater tax take for the exchequer in the long term, he explains.

Raymond McKenna, partner at Watson Wyatt, agrees that such changes would be worthwhile. "People who are forced into retiring and buying an annuity are in a very difficult position, because . . . then they will have to consolidate [their] loss," he says.

He explains that there is a double-whammy for older people in DC schemes who were exposed to the stock market, as their pensions were most likely "vastly underfunded" in the first place, so they could ill afford the recent losses. "We need to try and help those people."

He also makes the point that this issue is not something to be debated for several years. It is an issue that needs to be addressed urgently.