2. Approaching retirement
“The extent of any impact from inflation on those approaching retirement will depend on how they plan to take an income.
“It’s worth remembering that while for some people retirement remains a fixed point in time, for many it is much more flexible.
“To provide a bit of context, official figures suggest that around 3 people choose to take a flexible income through drawdown each year for every 1 person who decides to buy a guaranteed annuity income from an insurance company.”
a) Planning to buy an annuity or take all your pension as cash
“For anyone planning to buy an annuity, the aim of the game in the years approaching retirement is to build-in certainty.
“This usually involves shifting away from equity investments and into bonds and cash as your chosen retirement date approaches.
“One of the consequences of ‘derisking’ during a period of high inflation is that you’ll almost certainly be locking in real-terms losses on your money.”
Example
Take someone with a £100,000 pension who plans to buy an annuity in 5 years. As a result, their fund is shifted into bonds and cash as part of a ‘derisking’ strategy.
If during that period inflation runs at 5% a year and their fund after charges delivers returns of 1% a year, then in ‘real’ terms when they reach retirement their fund will have plummeted in value to just £82,000.
However, it’s worth remembering bond prices should, in theory at least, move in the opposite direction to annuity rates, meaning if returns on those investments are lower in the run-up to retirement then the annuity rate available should be higher.
For someone planning to cash out their entire pension then the derisking principle is similar – assuming they have something specific they want to spend the money on.
Withdrawing all your pension in one go potentially brings into play a whole host of other risks, including paying too much tax on your withdrawals, having your fund eaten away even further by inflation, and running out of money early in retirement. It is therefore a decision that comes with a severe health warning.
b) Entering drawdown
“For those planning to take an income via drawdown, there is less of a need to derisk your fund as you approach ‘retirement’ as the bulk is likely to remain invested for the long-term.
“If you’re planning to take your 25% tax-free cash and have specific spending plans for that money then you might want to derisk that proportion of your portfolio.
“It also makes sense to have at least 12 months’ spending in cash once you enter drawdown to fund your retirement plans.”
3. Taking an income from your pension
“The impact of rising prices on retirement incomes will depend in part on how that income is taken. Let’s take each of the major conventional pension income routes in turn:
a) Drawdown
“Anyone keeping their pension invested via drawdown has the flexibility to adjust withdrawals to take account of rising living costs.
“This has the advantage of allowing you to maintain your living standards even during periods of high inflation. However, ramping up withdrawals will also increase the risk of running out of money early in retirement.
“What is sustainable will depend on your personal circumstances and investment returns. Anyone considering hiking withdrawals should make a budget if they haven’t already as inflation varies depending on how you spend your money.
“Once you have done this, think about the sustainability of your withdrawal plan and see if there are any day-to-day lifestyle changes you can make to help your money stretch a bit further.”
