Personal Finance: Should I take money out of my pension at the moment?
- Credit: Chadwicks/Getty
Richard Ross, director of wealth managers Chadwicks, on whether or not now is the time to extract cash from your pension.
This didn’t used to be a problem.
There was a time when we got to 65 we would take our pension pot and buy an annuity – a guaranteed pension for the rest of our lives.
MORE: Personal Finance: What do I do if coronavirus has impacted the value of my investments? A combination of very low interest rates and the advent of pension freedoms has meant more of us are shunning the certainty of an annuity for the flexibility of simply drawing money directly from our pension fund.
However, the risks of this approach become all too apparent when markets take a turn for the worst, leaving us worried about whether we should draw any money from our pensions.
While we’re saving money, a dramatic fall in markets is an opportunity to pick up assets cheaply and benefit in due course from their recovery.
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However, once we’re retired, we run the risk of drawing down on depressed assets that then never have the opportunity to recover. This ‘sequence of return’ risk can devastate pensions, so we have to be careful about how, rather than when, we draw money from our pensions.
We like the idea of an investment cascade.
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Imagine your pension is split into three pots.
The first pot holds two years’ worth of income and is invested in cash or near-cash.
It will probably lose money in real terms but that is the price of security. In the second pot is the equivalent of three years’ income.
This is invested in lower risk assets that will give a modest real return but have reasonably low volatility – typically corrections are small and recover within twelve to eighteen months.
In the third pot goes all the rest, invested in higher risk assets that are likely to generate a meaningful real return.
MORE: Personal finance: What happens if I can’t pay my car PCP because of coronavirus?When things are pottering along nicely, income is taken from the first pot, which is replenished from the second which in turn is topped up from the third.
As there is real growth in the third pot it cascades rising income through the system. When the markets go pear-shaped, we know we have two years’ worth of secure income in the first pot and a further three years’ worth in the second pot. This means we can leave the third pot alone for up to five years to recover.
This is fine if your pension is made up of a series funds, each investing in a discrete area. You can draw your money from those areas that haven’t fallen, or have fallen least, leaving the rest to recover.
It is slightly more complicated if you are invested in a single fund – say a managed or multi-asset fund.
Underneath it will be invested in a range of assets, but you can’t pick and choose which to sell.
If this is the case you need to speak to an adviser who can help you disentangle the fund while keeping you in the market.