Remember that pension savings are for the long term
The current global stock market turbulence will no doubt be concerning for individuals whose pension savings are invested partly or fully in these markets. If you have a defined contribution pension scheme – whether private or through work – your savings have probably also been impacted as a consequence of coronavirus (COVID-19).
This is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. In defined contribution plans, future benefits fluctuate on the basis of investment earnings. This is because pension schemes invest in the stock market too, so big rises and falls will have an impact on how much is in an individual’s retirement pot.
Time for markets to recover
It’s really important to remember that pension savings are for the long term. If you’re young and currently paying into a workplace pension, then there is time for your pot to achieve growth over the long term and recover from fluctuations in the stock market that occur in the short to medium term. You shouldn’t be too concerned, as you have many years ahead of you, and this will provide time for markets to recover before you take your pension income.
If you’re older and closer to retirement, your retirement pot may also have been impacted to some degree. However, you may have seen your funds lifestyled. This means your pension will have been moved into predominantly less risky funds and invested in ‘safer’ places such as in cash, gilts or bonds, which are lower risk and usually offer a fixed rate of return. The older you get, the more schemes tend to choose to invest in such assets to limit investment risk. However, not all pension schemes offer automatic lifestyling.
If you’re about to retire and were planning to buy an annuity, you face an additional challenge. In March, the Bank of England cut the base rate twice in just over a week in a further emergency response to the coronavirus pandemic, reducing it from 0.25% to 0.1%. This has meant annuity rates have also fallen. An annuity is a type of retirement income product that you buy with some or all of your pension pot. It pays a regular retirement income either for life or for a set period.
If you are thinking of securing an income by purchasing an annuity, the recent volatility shows the importance of gradually reducing the risk in your portfolio as you approach your expected annuity purchase date. Doing this provides greater certainty over the secured income you can expect to generate from your fund.
If we continue to see a protracted period of negative investment returns, perhaps those most affected will be people taking an income from their pension pot through drawdown. If you’re already using drawdown, or plan to move into drawdown soon, you might also want to avoid taking out any more than you need to while fund values remain depressed. The more you can leave invested, the more you will benefit over time once there is a recovery.
Drawdown is a way of taking money out of your pension to live on during retirement. You have to be aged 55 or over and have a defined contribution pension to access your money in this way. You keep your pension savings invested when you reach retirement and take money out of, or ‘drawdown’ from, your pension pot. Since your money stays invested, and it’s usually in the stock market, there is the risk that your fund may fall in value. The upside is that investment growth can provide higher returns and see your pot continue to increase in value.
Another option to consider, if you are still in the process of saving for your retirement and if appropriate, could be to increase your pension contributions. Even though your strategy may depend on the movement of the markets, increases in contributions over the long term can make a difference to your eventual retirement pot value, if it coincides with the market recovery.
Again, there is no need to panic – at this stage, we do not know what the long-term implications of coronavirus will be. Your financial adviser can help you see the bigger picture, weigh all your options and take a balanced assessment of your risks.