Stock market crashes are painful for all investors – but they are particularly vicious when they hit you at the point of retirement. So when Bank of England deputy governor Sarah Breeden said recently that visions of a collapse are giving her sleepless nights, her words struck fear into the hearts of many would-be retirees.
Retiring into a market slump with a stock market-lined pension pot makes savers vulnerable to a nasty trap known as ‘sequencing risk’ – in simple terms, withdrawing money at a bad time. This can result in large losses that dash retirement dreams and leave savers permanently poorer.
Clare Moffat, who is a pensions and tax expert with Royal London, says: ‘Taking money out at the wrong time can lead to a reduced income in retirement.’
The effects are most destructive if markets fall just when you retire or soon after. But what can you do? And is it even worth putting retirement on hold for a while and carrying on at work?
Is a crash likely?
It is highly unusual for a senior figure at the Bank of England to be as outspoken as Breeden. It is an indication the threat of a crash is being taken very seriously in Threadneedle Street.
Similarly, legendary US investor Warren Buffett recently declared some prices are ‘silly’ after Wall Street hit record highs despite the Iran war, fears of an AI bubble and worries over ‘shadow banking’.
However, a collapse is not certain and no one can say how bad it might be or when it might happen.
Those who have a ‘defined benefit’ pension from an employer are not affected because their payments are linked to their final salary, not investment values.
Experts warn taking money out of your pension pot at the wring time can be dangerous
The state pension is not dependent on what happens on the markets either.
‘Defined contribution’ pension pots from an employer – the most common plans offered in private sector workplaces – are in the frame, as are self-invested pension plans (Sipps).
Is my pension pot safe?
‘The trouble with retiring into a falling market is that the maths can turn against you quickly,’ says chartered financial planner Richard Watkins, of Continuum.
Suppose you have a pension pot of £400,000 and take the maximum tax-free lump sum of £100,000 on day one of retirement, leaving £300,000 to give you an income.
You decide to make withdrawals at the start of each year to provide a retirement income at 3.5 per cent of your pot, a rate most advisers would consider prudent.
If your pot goes up in value by 5 per cent in each of the two years after you retire, you would have £303,975 at the end of year one, and £308,003 at the end of year two. But if your pot falls by 10 per cent a year and you still withdraw at 3.5 per cent, at the end of year one, you would have only £260,550 and at the end of year 2 you would have £226,288.
Your savings are down by nearly a quarter. Ouch.
Is a ‘lifestyle’ fund OK?
Not necessarily. Many employer defined contribution pension schemes automatically shunt people into supposedly lower risk ‘lifestyle’ funds that invest heavily in bonds ahead of retirement.
Former pensions minister Baroness Altmann says there are no guarantees with investments
These are not bullet-proof – as many savers unlucky enough to take their pension in the Liz Truss bond meltdown of 2022 found to their cost.
Former pensions minister Baroness Altmann says: ‘People were getting a pension quote in, say March, and then in October their fund was worth maybe 30 or 40 per cent less and they couldn’t retire in the way they wanted.’
Experts fear a similar scenario may unfold. Markets are nervous a new Labour leader, such as Angela Rayner, may play fast and loose with borrowing to spend more on welfare. ‘The message with investments is there are no guarantees,’ says Baroness Altmann.
Do I delay retirement?
Putting a long-planned retirement on hold is often not a happy thought, and it is not possible for everyone. ‘This is a hard call if a client particularly wants to retire, as we just do not know when these downturns will occur,’ says Lisa Doig from financial advice firm Thorntons Wealth.
‘We would never put anyone off. Our clients have the expectation that investment is for the long term… and markets have tended to recover over the long term.’
Nonetheless, if you can meet some of your income needs from earnings – possibly by going part-time rather than stopping work completely – it might make sense in any shares’ meltdown.
Baroness Altmann is a fan of what she calls ‘part-tirement’ and continuing with some paid work rather than a screeching halt. ‘I’d recommend taking as flexible an approach as you can,’ she says.
Do I take my lump sum?
Many people eagerly anticipate taking their tax-free lump sum at the earliest opportunity, perhaps to pay off a mortgage or to finance a trip around the world. Normally, it is capped at 25 per cent of your pot or a maximum of £268,275.
But Moffat says: ‘Think about whether you need it all right now. Maybe you’ve committed to major purchases and need to – but Royal London research showed over a quarter of people who took all of their tax-free cash just put it into a bank or savings account.’
Taking it gradually, she adds, could mean you end up with more.
She explains: ‘Say your pension is worth £400,000. You could take the full 25 per cent tax free cash of £100,000 and move the rest into drawdown. Or instead, you could take £25,000 tax free cash now and move £75,000 to drawdown, leaving £300,000 in your pension.’
‘Then if markets improve and your pension increases to £350,000, you’d be able to take 25 per cent of that, which is £87,500, and move the other £262,500 into drawdown. That would mean tax-free cash of £112,500 instead of £100,000.’
What else can I do?
If you can put off making withdrawals from your pension pot in bad markets, it makes sense to do so, says Watkins.
Ideally, savers would have planned ahead and built a healthy reserve of cash. ‘Perhaps hold two to three years of overheads in cash for the first two to three years of withdrawals,’ he adds.
‘The best way to protect a retirement pot in a falling market is to take as little as possible from it while share prices are low. If you can use savings or part-time earnings to delay drawing on your pension and markets recover, it could make a long-term difference. And diversify the portfolio across bonds, shares and other assets.’
Savers might consider using part of their pot to buy an annuity, which pays a guaranteed income.
Financial planner Louise Oliver, of Piercefield Oliver, says: ‘This is a good solution for cautious investors who would lose sleep over the uncertainty of stocks and shares.’
You can build in protection against inflation and an income for a surviving spouse. But annuities cannot be passed to your heirs and can be poor value if you die young.
It’s a good idea to seek guidance or consult a professional financial adviser, ideally well before you hope to retire so you can plan for perils such as sequencing risk.
Markets will always be volatile, so the best approach is to build in adaptability – which could include being flexible about when you retire and keeping a foothold in the world of work.