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Pension freedom turns sour as turmoil hits savings
The main challenge of pension freedom is ensuring you don’t outlast your savings. It’s an even bigger problem when markets are in turmoil.
by Michelle McGagh on Feb 11, 2016 at 12:04
If you used pension freedom to invest your money in a drawdown policy, the chances are you’ve been hit by the market slump that has seen as much as 20% wiped off indices as fears for the global economy grow.
It’s undoubtedly a worrying time for those who are watching a lifetime of savings being eaten away by stock market turmoil and their income squeezed but experts are urging retirees to stay calm and resist the urge to ditch equities and run.
‘Where the market bottoms out is anyone’s guess as it is being driven by sentiment,’ said Adrian Lowcock, investment expert at AXA Wealth.
‘The problem is that the global economy is taking a slow down but that should not be read as a crash or collapse.’
Lowcock said the biggest issue for retirees was income and how to protect it in falling markets, especially if they have failed to invest in a wide range of assets – such as equities, bonds and cash - known as diversification.
‘The simple answer is there is little you can do in the current sell off,’ he said. ‘You have seen a 20% fall in equity assets and possibly more.’
Risky time to tweak
Lowcock (pictured) said the bottom of the market was a ‘risky time to rebase your portfolio’ and move into lower risk assets, as it requires 'crystallising' losses made on your current investments.
‘If you can afford to do it then it might be the right thing to do,’ he said. ‘If you are in drawdown and 100% in equities, then you have taken a 20% hit so if you diversify out of equities you effectively realise that fall. Then you build a diversified portfolio from then but you have to accept where [your portfolio] is at.’
If you cannot afford to realise the losses you have already made then you will have to hang on until the market recovers but this possibly means having ‘to tolerate further losses which is difficult to do in retirement’, said Lowcock.
‘If you’re not in retirement then you can invest more money [as the market is cheap] and wait for a rebound,’ he said.
Income is the most important part of a retiree’s portfolio and is typically received from fixed income investments like bonds and gilts and also from equities in the form of dividends.
‘If you are in drawdown you need to look at what income you are getting. Equities have fallen but dividend yields have not been impacted yet so your income may not be impacted,’ said Lowcock. ‘However [the impact of a stock market fall] may begin to feed through. If things [in the markets] get worse then the dividend is going to go down.’
Threat to dividends
Dividends are definitely at risk this year, according to Capita Asset Services, which compiles the quarterly UK Dividend Monitor study.
It has predicted that dividends, excluding special payouts, will fall to £83.8 billion this year from £84.6 billion last year. The fall would make the first since 2010, when companies were still struggling after the financial crisis.
Adrian Boulding (pictured), a pensions expert at the Tax Incentivised Savings Association (Tisa), said retirees needed to look carefully at the income they were taking from their drawdown policies.
‘You need to go back and consult the financial plan you made at the outset [of retirement],’ he said. ‘What did you set out for when the [investment] risk you took comes back to bite…What were you going to do? Hopefully you know which of your expenditures you can turn down.’
Boulding added that retirees should ensure they had enough of their pension in cash to cover their expenditure for a couple of years so they do not have to eat into the capital of their pension.
‘Do not panic, you can use the cash in your pot and make sure you are not selling assets at a distressed value,’ he said.
‘Left to their own devices people will continue to eat in to their pot or sell out at the bottom [of the market] only to buy again at the top of the market.’
Preserve capital if you can
Lowcock agreed that eating into your pension capital was one of the worst things you could do in a downturn and retirees should resist the urge to take large lump sums.
‘If you are drawing capital [from your pension] then you are going to be really hit,’ he said.
‘That £10,000 you take is going to be an even greater proportion of your portfolio [because the portfolio has shrunk].’
While pension freedoms seemed like a great idea when they were introduced last year when the stock market was on an upward trajectory, the recent market turbulence shows retirees need to consider a financial plan, starting with cash.
‘You need to create a financial plan,’ said Lowcock. ‘You need two to three years in cash [to cover your bills] so you do not need to draw on your portfolio in weak markets.
‘Think about the other cashflow you have coming in from the state pension and income from ISAs. Then have a part of the portfolio that is income-producing, that is invested in bonds, so that generates a yield and income and you are topping up your cash pool with a natural income.’
After you have a base of income you can then look at higher risk equity investments.
‘Then you have higher risk assets further upstream, which had a bed of income and also have the potential for capital growth but you do not necessarily need to touch these investments for three to five years,’ said Lowcock. ‘In a falling market it is not great that the equity income has fallen but you accept that stream of income will dry up for a few years as you have other income to rely on.’
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