How to de-risk your pension savings?

Summary 

  • De-risking your pension savings is done by moving from high-risk to low-risk assets in the years before retirement.
  • After the introduction of pension freedom April 2015, more people are gradually shifting from annuity to drawdown schemes.

Maintaining a comfortable lifestyle with the same standard of living after retirement is among the most important financial goals of people. Pension schemes are the best long-term investments to secure your future and have a comfortable life post-retirement. As you approach your retirement age, you need to figure out the allocation of money you’ve saved towards your pension during your working life, if you’ve saved into a defined contribution pension scheme. People usually prefer to de-risk their savings as they approach retirement, to protect their retirement corpus from market volatility, and make sure that the fluctuations in the market conditions don’t drastically impact their pension pot.

Understanding the pension pot

Pension schemes can be classified into personal, workplace, and state pension schemes. The total pension contributions you and your employer make towards the savings for your retirement form the pension pot, which also includes any capital growth earned from the fund’s investments. But the pension pot doesn’t include the amount you receive as State Pension by the government. Your pension pot can be accessed at a certain age set by your pension fund provider, which is generally 55 years. All pension schemes work according to their individual rules, and money can be withdrawn earlier than the pension age in case of poor health or disability.

                           

Effective Guide to Pension De- Risking

 

A lumpsum payment can be received in one go if the pension pot is closed, or else it can be treated as a bank account from which withdrawals can be made as needed. But withdrawals may not be offered by all pension providers, charges per withdrawal may be high, and there may be a limit on the number of withdrawals.

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Thus, annuity comes into picture, which converts your pot into an annual pension, and provides you with a regular income stream for the rest of your life or a specified time period. Getting annuity from any pension provider is your legal right, so it’s better to choose one that offers you the best deal.

Is annuity a good option?

Conventionally, de-risking of pension has meant moving towards less risky assets with the help of defined contribution (DC) schemes, which automatically move the client’s money into cash and bonds, which are less risky than stock markets. Compulsory annuity purchase was a good option when life expectancy was limited and people wanted to avoid losing money from risky investments before they retired, but annuity has many disadvantages as well. After purchasing an annuity and determining the income to be received, you don’t have an option to change your plan or pension provider. With rising inflation levels and an increasing cost of living, you may not get the flexibility to increase your income in future. A certain amount may also be charged by the pension providers for purchasing annuity. Also, the changes in stock markets and the economy may also have an influence on annuity rates.

Also read: What are the different types of pensions?

What’s the alternative?

Since pension freedoms was introduced in 2015, there is no need to shift from high risk to low-risk assets as approaching towards retirement. This shifting was done on the assumption that people would go for an annuity. As the decision-making power of people is increasing, and they can determine how to save, spend, or invest their pensions, more people are shifting towards drawdown schemes. In drawdown schemes, a part or your pension pot is invested into the stock market, which can provide income without any restrictions on the amount you can take. Thus, there is less need to change your asset allocation as you move towards your retirement age.

De-risking your pension portfolio

De-risking or 'lifestyling' your pension savings is generally done when you are preparing to buy an annuity. But de-risking could actually decrease your pension income, so more people are opting for drawdown schemes, which let them withdraw down money from their pension pots gradually over the course of their retirement. Usually, de-risking starts around 10 years before your retirement age, and it involves shifting your money into corporate and government bonds and cash from stock market-linked investments. Although shares-based investments might be riskier, but they offer higher returns and maximise your savings.

Also read: What is the over 80s Pension?

De-risking is generally automatically carried out by pension providers in a one size fits all approach, but you should be aware of the pace of de-risking, the money moving in and out of your pension pot, and the structure of your pension portfolio five years before you retire. De-risking can be done by people themselves and keeping majority of your funds invested in stocks and shares with little de-risking may prove out to offer you higher returns on your pension savings.

A diversified portfolio of stocks and shares should be maintained, with a defensive core of bond funds and gilts which are safer investments. The returns from the best-performing investments can be taken to purchase more fixed-income investments to reduce the risk. But should you de-risk or not?

Also read: Roth IRA: Is it the best way to invest money for your retirement years?

Normally, your pension provider automatically starts de-risking 10 years before you retire, but you can halt the process, or start late and go for riskier stock investments as per your risk appetite. The amount of money you invest in your pension savings should be considered to determine if the better option is buying an annuity or going for a drawdown scheme and gradually withdraw from your pension pot. Pension freedom sounds great, but it also means you will have to take more decisions in the future, thus professional advice is very important even if you are not de-risking, which will in turn lead to extra charges.

Summing up

Since pension freedom has been introduced, de-risking your pension savings is now a choice. An appropriate investment allocation of risky and safe assets can be made with the help of an adviser, and your money can be moved from stocks and shares to bonds as per your risk aversion. To increase your income from your pension investments, you may go for alternative assets, such as property and infrastructure, and you may also move away from the UK market to broaden your option.

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