Since April 2015, people who reach retirement have had much greater flexibility over how they use their pension funds to pay for their later years.
Until that point, the most common method was to use most of the money to buy an annuity, which provides a guaranteed regular income for life.
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Now, however, it is much easier to leave money invested in the stock market, say, while making regular withdrawals to cover living expenses – a process known as drawdown.
The drawdown option means that your investments still have the opportunity to grow over the course of your retirement. Provided markets perform reasonably well, this should make you better off overall.
What does this mean for investment strategies?
This rule change, and specifically the fact you will no longer be forced to “cash in” your whole pension when they reach retirement age, has implications for how you invest in the years before you take your pension.
For those retiring before April 2015, a typical investment approach involved gradually moving from high-risk to lower-risk assets in the decade or so before retirement.
This was in order to reduce the risk that a pension would suddenly lose a large chunk of its value if the stock market became more volatile just as the investor was about to buy an annuity.
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Funds which hold a larger proportion of low-risk assets such as bonds, shares in blue-chip companies and even cash, are typically less prone to wild changes in value, and are therefore more suitable for people who will soon need to withdraw their money.
Now, though, more and more of us are keeping much of our pensions invested after we retire – and this means there is less of a need to “de-risk” in the run-up to retirement.
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An alternative approach
Keeping your pension invested in higher-risk shares for longer gives it more chance to grow – but the opposite is true as well, and you could be hit harder by any falls in the markets.
What the drawdown option means, however, is that you can keep your money invested over a longer period and thereby hope to ride out any losses in value.
If you are planning to take some cash from your pension when you retire (up to 25% can be taken tax-free), or if you want to use a small proportion of it to buy an annuity, it could be worth de-risking a chunk of your fund in the years before retirement.
As for the rest of it, the level or risk that someone in their 30s or 40s could take on might not be appropriate for an investor in their 60s or 70s – especially one who needs to make regular withdrawals from their fund.
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But it could be worth continuing to take on a reasonable level of risk so that your fund can continue to grow in your later years.
As ever, if you are unsure about what approach to take, seek independent financial advice.
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