Why TDFs are a different way of preparing for retirement

This article is part of
Guide to using Target Date Funds

“There is this whole idea of a cohort where you’re grouping members of a pension scheme by their age, and it’s being run in the best interests of that cohort based on life expectancy.”

Membership appropriate

In the US, where the vast majority of pension saving is done through TDFs, a huge amount of research has been done to ensure that the scheme allocates its funds correctly based on lifestyle and life expectancy of that cohort.

For example, employees in a professional occupation will be on a different glidepath from workers in a steel plant.

Mr Cobbe explains: “[In the UK], Nest has designed their default strategy based on the Nest target group. 

"These are people who wouldn’t be in a private scheme, and they’re not high earners. It’s a catch-all, and they have to make sure the investment strategy is appropriate for that group - they have an obligation to make sure it’s appropriate to their membership.”

As the rules have changed over what one can do with one’s pension fund at retirement, so the way TDFs are sold have changed.

Emma Douglas, head of DC at Legal and General Investment Management, says: "The old style target date funds, you would have one target date for each year, and that would be aligned to 25 per cent tax-free cash and focusing on buying an annuity, and you would have the same process in terms of aligning these TDFs to the outcome.

"Given the pension freedoms, generally people aren't buying annuities at 65. They might be taking some tax-free cash and leaving some invested.

"A lot of research is done around pension freedoms, which just shows people don't really know when their retirement date is going to be."

This means that most of the retirement dates are done in three-year blocks or five-year blocks.

"You will be retiring around that date rather than you will definitely be retiring in that year," she adds.

This does affect the investment strategies.

Ms Douglas says: "You have one main pathway which leads to a typical outcome at retirement, and that outcome will vary.”

For example, it may need to keep funding the member into retirement. More people are looking at drawdown, she adds, but the TDF manager needs to keep the endpoint in mind.

“We can change the asset allocation in the fund and can change the glidepath pretty quickly.”

How TDF funds can be used will be covered in the next feature.