How certain are your retirement plans?

2022 was certainly an interesting year for the world. In the UK alone we had three Prime Ministers, four Chancellors, two Monarchs, a plethora of strikes and a not-so-mini “Budget”. This is without even mentioning a war, the cost-of-living crisis, a pandemic that is still far from over in certain parts of the world, the ongoing climate crisis and the seemingly endless Brexit negotiations. Markets were of course not exempt from the various twists and turns of last year, in fact quite the opposite. 

As most of the world emerged from two years of being in and out of lockdowns, global supply chains buckled as they struggled to cope with the mass reopening of the Global Economy. Russia’s invasion of Ukraine sent energy markets into a frenzy, sparking a cost of living crisis, in turn driving strikes across a number of industries as workers demanded higher pay to help with record energy bills. This all helped to bring UK inflation to a 40 year high of 11.1% in October 2022. This was not aided by Liz Truss’s brief premiership, as the former PM and her chancellor sent the UK Bond Market haywire with their drastic proposed tax cuts, causing the Bank of England to intervene in order to rescue the fate of many Final Salary pension schemes.

With global stock markets down by -8.08% as measured by the Morgan Stanley Composite Index (MSCI) All Country World Index, and some regions down closer to -20%, 2022 was largely a year to forget for equity investors. Unfortunately, unlike previous downturns, there was little respite to found in bonds with the Bloomberg Global Aggregate Bond Index down -16.25% in Dollar terms.

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Graph: FE Analytics

Have your retirement plans been derailed?

As a result, many investors will have seen the value of their portfolios fall in 2022. For those approaching retirement, this may have called into question their previous plans, with the Office for National Statistics reporting a fall in the value of private sector defined contribution and hybrid pension scheme assets of -12% from 31 March 2022 to 30 June 2022. For those not lucky enough to have a guaranteed, and usually inflation linked, retirement income provided by a generous Final Salary pension scheme, many prospective UK retirees are reliant on Defined Contribution (sometimes called Money Purchase) pension plans to provide for them when they stop working. 

Unlike old-style Final Salary schemes, where all of the investment risk is borne by the former employer, Defined Contribution pensions are invested on an individual basis into global stock markets. Plan holders are then reliant on a combination of long term market returns and the wonders of compound interest to increase their retirement pot to a value that will allow them to sustain their desired level of expenditure in retirement. 

Thanks to auto-enrolment rules introduced by the Government in 2012, many people’s retirement funds have accrued without them so much as opening an account. Clearly, some people have a far greater interest in managing their pension’s underlying investments than others, with the rise of online DIY platforms this has made this more easier to do than ever, with many platforms offering unlimited trades and special offers on new fund launches. 

For those less interested in becoming the next Warren Buffet, your pension provider may have kindly sorted this all for you! The vast majority of workplace pension schemes are invested in a “lifestyling” strategy as default. This aims to put scheme members into riskier assets, like equities earlier in the careers to benefit from the greater levels of return that they have experienced historically. As a member moves closer to their nominated retirement age, the pension provider automatically reduces the level of riskier assets in the plan in favour of more conservative alternatives. The result is that the pension should be sat in one of the safest asset classes – usually government bonds or sometimes cash at their chosen retirement date, ready for the member to access their funds without being subject to the whims of market volatility. 

How does lifestyling work?

Sounds great right? How thoughtful of your good old pension provider, looking after that pot from that job in your twenties for all those years. If you’re beginning to get the sense that all of this sounds a little too good to be true then that’s because it sort of is!

“Lifestyling” funds are fundamentally flawed for two reasons:

The first, is that the above strategy only works if the assets assumed to be risk free, actually are. The chaos in UK Bond markets, sparked by October’s “Mini Budget”, put many lifestyling funds in the spotlight for their use of UK Government debt as a safe alternative to cash as a place to store pension funds for those nearing retirement. The result was that many of those nearing retirement in the final stages of the lifestyling process saw sharp falls in the value of their pots sparked by a mass sell-off in UK Government debt, as the countries fiscal prudence was called into question by Global Investors.

Bond Markets in 2022

Are annuities looking more appealing?

The second issue with lifestyling, is that the notion of having a pension entirely de-risked ready for the day you retire only makes sense if you are planning to use the whole pot to purchase an annuity. Due to rises in bond yields, annuity rates have increased steadily throughout 2022 to the extent that they now present an option well worth considering for certain retirees for the first time in many years. Our recent article covers all things annuities in more detail if you’re keen to learn more.

With this being said, annuities are by no means right for everyone. For many people, drawing upon their pension pot(s) flexibly, either through regular income payments or ad hoc withdrawals, will be the way in which they access their retirement funds. 

The ONS estimates that someone at the average retirement age of 65 can expect to live to an average of 85 for men and 87 for women. There is also a 1 in 4 chance of living to 92 for men and 94 for women; and a 1 in 10 chance of living to 96 for men and 98 for women. 

This means two things, firstly that there is good chance that your pension will need to last you at least 20 years, but potentially much longer; secondly, and related to the previous point - some of your pension may not be touched for another 20 years. Therefore, this pot should not take the same level of risk and have the same investment strategy as the money you will be drawing upon in the first few years of retirement, which should be sat in cash ready for you to access.

Segmenting your pension into different pots

This is by no means anything ground-breaking; by segmenting your pension across different strategies, you are simply taking advantage of timescales. This means that your longest term money can work harder for you, but that the money you need to fund the next few years of living is sat in cash, taking no investment risk. Holding adequate cash reserves either inside or outside a pension is absolutely crucial to any retirement plan. By holding a few years’ worth of expenditure in cash you give yourself time to ride out any of the shorter term volatility in markets, meaning you are never forced to sell down upon your invested wealth at an importune time in market cycles in order to fund your day-to-day expenditure needs. Luckily, with interest rates being at their highest level since the Financial Crisis. The returns from holdings cash are far better than anything seen for many years [insert savings champion plug].

As the above illustrates, planning appropriately is vital in ensuring sustainability throughout what will hopefully be a long and enjoyable retirement. Making sure that a robust retirement strategy is in place well in advance of actually retiring will allow your money to work as hard as possible for you, whilst also ensuring that you can continue to live your dream retirement without the need to worry about the ups and downs in markets.

If you’d like to learn more about how you can plan your own comfortable retirement, why not get in touch and speak to one of our advisers. We’re currently offering anyone with £100,000 in pensions, savings or investments a free initial consultation worth £500.

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Please note: A pension is a long term investment. The fund value may fluctuate and can go down. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation. The Financial Conduct Authority (FCA) do not regulate estate or cash flow planning, or tax advice.