Investing in shares (equities) is a long-term game and requires an acceptance that the value of your investment can go down in value, sometimes by quite a lot, as well as up. When falls occur, they are often fast and unexpected.
To cope with market falls, you need to have plans in place before they happen. This short guide is for investors who are in their mid 50s or older, but haven’t yet started taking their retirement benefits from their pension plans. Its aim is to help them to prepare their portfolios in advance of future market turmoil.
Would a stock market crash affect your pension?
There’s potentially good news for investors over the minimum age at which they can take their pension (55). Depending on the type of pension they hold, a stock market crash may not affect their savings at all.
This is because, if you’re in this position, your pension pot may no longer be invested in shares. Automatic mechanisms in workplace pension schemes may have been in place to move your accumulated fund into less risky/volatile investments. Alternatively, your savings could be in a with-profits fund, which is designed to smooth out the ups and downs of investment returns, sometimes also providing valuable guarantees.
People in this age bracket, whose pension is still mainly invested in shares (equities), will feel the pain of a stock market correction hardest. Just as you are about to retire, your accumulated pension fund could fall by 10%, 20% or, in extreme cases, even more.
If you have a defined benefit pension often called a ‘final salary’ or ‘average salary’ pension, you may feel the pain of a stock market correction a bit less. If you have one of these, you don’t need to worry about stock market movements. The pension scheme trustees and your current or ex-employer are responsible for making sure you get the promised amount. Even if your employer or ex-employer goes out of business, there is an insurance scheme called the Pension Protection Fund. This will pay your pension up to a cap of around £30,000 a year.
People in this position may also have other investments such as ISAs, impacted by a stock market correction.
Things you might want to consider
- If your pension is invested in shares, you could consider working for a bit longer. This will allow time for your investments to recover if the market goes up in the future. It will also give you a regular income from which to save more to close any shortfall between your desired and actual level of income. Finally, if you are retiring later, your savings don’t need to last as long, meaning that you can afford to draw a higher income than someone who retires earlier. Annuity rates also improve with age, so buying one when you are older will generally result in a better rate. However, long-term interest rates and other factors also affect annuity rates, so growing older doesn’t always result in higher annuity rates.
- If you are going to retire and the stock market hasn’t been performing well, you could think about accessing your share-based pension investments later. For example, could you afford to live off other pensions such as the state pension or a defined benefit pension? Do you have other investments such as cash ISAs that haven’t been affected by stock market movements? If so, you could consider drawing income from these. Alternatively, you may be able to work part-time in your current job or a new job to supplement your income.
- If you have with profits life policies such as endowments or if your pension is invested in a with profits fund, the pay out from these policies is unlikely to be affected in the short-term, although future bonuses may be lower if you are retiring the next year or later. With profits funds aim to smooth out the ups and downs of investment returns. Some with profits funds also provide a guarantee that your investments won’t fall in value or that they will go up by at least X% a year. These guarantees are valuable and you should ideally take advice before cashing them in or switching to other investments.
- Your ISA holdings may be targeting shorter-term needs such as paying for a holiday of a lifetime or helping your children get on the property ladder. Given the fact that there may not be time for investments to recover their value over the shorter term, some people choose to hold investments in low risk assets such as cash deposits. For longer-term goals, a broader mix of investments could generate a better rate of return. Investments held in shares are usually regarded as long term and therefore have the potential to ride out some volatility in the market.
- If you do defer taking your pension, work out whether your investments are on track to provide you with the level of income you need. There are tools and calculators available that will help you do this. If you are coming up short of your goals, you could consider paying more in.
For more information about managing your finances in retirement, see the I’m approaching retirement page of our website.
If you want personalised advice you should speak to a financial adviser. You can find a financial adviser in your area at www.unbiased.co.uk.