Over many years it was considered appropriate to reduce your investment risk just before retirement.
After all, if you are soon to be taking money out of your pension fund, it’s logical to want to protect its current value to maximise those withdrawals.
But there are essentially two choices when it comes to your retirement income. Depending on which one is right for you will impact the investment risk you should be taking.
Get the wrong risk level and you could be destroying your retirement.
Two options when it comes to investment risk just before retirement
#1 – Annuity
Traditionally, back in the ‘old days’ most people would save into a pension and then at their chosen retirement age would use their pension to purchase an annuity.
The annuity would then pay you a guaranteed income for the rest of your life.
This type of product and approach is still available today and is appropriate for you if you are someone that is nervous about leaving your money invested and wants certainty of income.
If this option is for you then it definitely makes sense to reduce your pension investment risk just before retirement. This would mean selling equities (stocks and shares) and moving more into cash and bonds (fixed interest). You would usually do this over a 10 year period just before retirement.
The reason for this is because you want the maximum pension fund value available at retirement to purchase the biggest annuity income you can.
#2 – Drawdown
However back in 2015 Pension Freedoms were introduced which gave people much more flexibility as to how they withdrew funds from their pension.
For example, from age 55 you can now withdraw the whole lot in one go. Take some and leave the rest. Or take a regular withdrawal which you can stop, start, increase or decrease.
This approach doesn’t give you certainty of income but it does mean you can be more flexible in your lifestyle.
If this option is right for you then reducing your investment risk just before retirement might not be right if your pension fund is to last as explained below.
Factors to consider for your investment risk just before retirement
According to the Office for National Statistics, the life expectancy for a 60 year old male today is 85 years and for a female 87 years.
But there is a 25% chance a man will live to 92 and a woman to 94, and a 10% chance a man will live to 97 and a woman to 98.
So that’s a potential 38 year retirement!
Let’s look at an example of a pension pot size of £100,000 and assume that a person at age 60 wants to drawdown £4,500 per year, increasing by inflation each year. The table below shows the probability of being able to do this until age 98 without running out of money.
|Low risk investments (3 out of 10)||46%|
|High risk investments (7 out of 10)||59%|
(figures calculated 15/06/2020 using CashCalc Drawdown Monte Carlo Simulator)
As you can see, reducing investment risk just before retirement if using pension drawdown can result in you running out of money before you run out of life!
This is all because of inflation. Prices for the things you buy will continue to rise in retirement and after 38 years will look a lot different!
The only way to ensure your pension fund keeps up with inflation is to invest it.
Yes, if your investment timeframe is less than 5 years until retirement (because this is the point at which you will purchase an annuity) then of course it makes sense to reduce your investment risk.
On the other hand, if you plan to use pension drawdown then your investment timeframe is not 5/10 years, it’s 38 years! Therefore you need to be invested appropriately.
Be warned though, many pension funds default to investing using a ‘lifestyling’ approach. This means they automatically reduce your investment risk just before retirement, assuming you will be choosing option 1 above. If you plan to use the drawdown approach (option 2) you MUST review your pension investments immediately.
We have sophisticated tools that can model a range of scenarios showing you the impact if you were to reduce your investment risk just before retirement. If you would like help understanding which retirement option is right for you then please secure a free 15-minute call. You can speak to a Chartered Financial Planner who will listen to your situation, give you an outline of what you need to consider and guide you in the right direction.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.