The challenge of making your income last in retirement

5 pension changes facts


Jenny Holt

27th July 2015 at 8:52am

The new pension freedoms mean greater choice around when and how you access your pension money. It’s likely that, as a result, more of us will choose to invest our money and take an income from it – known as flexible income or drawdown.

You might choose to do this to try to meet various goals, such as being able to

  • keep your pension invested and give it the potential to grow
  • take regular income for day-to-day living, now and in the future
  • take ad hoc withdrawals for holidays or family occasions, or for essentials such as home repairs and health care
  • leave an inheritance to loved ones.

Balancing these competing goals is probably the biggest challenge when you’re taking a flexible income. Short term you need money to live on, yet you need your pension to last longer term too. If you’re choosing to take a flexible income, it’s important you do balance these different needs as this is where you can make or break your pension pot.

It’s also essential to keep checking the income you’re taking is sustainable and likely to last as long as you need it to. You may need to consider adjusting how much you income you take if necessary.

Different challenges for your money:

Growing your pension pot

When you build up your pension pot, your goal is relatively simple; build up as big a pot as possible by the time you retire. Most people do this by making regular contributions and investing for growth.

Taking money out of your pension pot

But when you choose to access your pension pot things get more complicated. There are different goals and timeframes to meet and, crucially, more risks to manage. Being aware of these will help you find a solution that will help you make your income last for the length of time you need it.

Investing for growth in retirement

In retirement, leaving your money only in cash or low risk investments is unlikely to give you the growth you need to make your pension pot last and keep up with the cost of living. Inflation may be hovering around zero (July 2015) but it’s been significantly higher historically. Even a 3% average rate of inflation can almost halve the spending power of your portfolio over 20 years*. And the reality is that most people underestimate how long they’re going to live.

Investing your pension money in retirement may help it last longer and keep up with the cost of living. But with the opportunity for growth comes an increased risk that your investments could fall in value. And in retirement this is further complicated by two big challenges.

What can happen to your money when you withdraw income

Taking a flexible income often involves withdrawing a fixed amount at regular intervals, a bit like paying yourself a salary in retirement. If the value of your investments drops then that fixed amount becomes a larger proportion of your overall pot.

This means that if you take money out of a higher risk investment when the markets have fallen, the impact of your withdrawals could be magnified and lead to your pension pot running out faster.

What can happen to your money in the early years of retirement

How your investments perform in the early years after you retire will have the biggest impact on how long your pension pot will last. Research** suggests that the return you make on your investments in the first three years of retirement could account for more than a third of the overall outcome.

So, if the value of your investments falls in the early years of your retirement, it could dramatically reduce how long your pension pot will last. This is because – on top of any magnifying impact I’ve described here – it’s hard for the investments to catch up after you’ve taken an income out while markets are falling.

Managing how much investments move up or down in these years is important, as it can ‘make or break’ your pension pot.
Managing how much investments move up or down in these years is important, as it can ‘make or break’ your pension pot.

We’ve produced a series of blogs that cover our top tips for investing in retirement. In these you’ll find more detail on the risks I’ve mentioned, cash versus investing and the importance of taking a long term view.

What’s the solution? Saving for the short and the long term

If you want your pension money to last, a mix of carefully managed growth and lower risk investments for your short and longer term needs could help.

A mix where your money goes into:

  • lower risk investments for spending today – to help protect against the early years risk I’ve mentioned above
  • medium risk investments for the longer term – so the money you’ll need in the future has the chance to grow and could last you longer.

Of course, it’s worth remembering that, as with any investment, the value of your funds can go up or down and may be worth less than what was paid in.

Finding balance

So it’s really all about balance and balance is not something you find, it’s something you create. And with new pension freedoms you’ve more opportunity than ever to strike a balance that suits you.

We’d love to hear from you…

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A pension is an investment. Its value can go up or down and it may be worth less than you paid in. Investment returns aren’t guaranteed.  Past performance is not a reliable indicator of future performance. This blog and any responses are not financial advice.

*Source: Standard Life, effect of inflation
**Professor Wade Pfau, Lifetime Sequence of Returns Risk, September 2013