How to invest your pension safely in retirement


Many older people are using pension drawdown schemes designed for investing as a place to stash cash instead.

Watchdogs have raised the alarm about the practice, amid fears people are taking what they perceive as the ‘safe’ option of cash without realising the pitfalls or missed investment opportunities. 

They are now floating the idea of making pension firms send regular alerts to anyone who keeps a pot in a cash fund for a long time.

Safe haven? Older people are sticking pension pots in cash, not investing to protect their income in old age

Safe haven? Older people are sticking pension pots in cash, not investing to protect their income in old age

Safe haven? Older people are sticking pension pots in cash, not investing to protect their income in old age

We explore why some people are using cash funds in income drawdown schemes rather than investing – there are some good reasons for doing so, as well as downsides.

We also look at what investments might be suitable for ultra cautious retirees, who currently keep pots in cash. 

Why are watchdogs worried about retirees putting pensions in cash?

Pension freedoms reforms have given over-55s full control over their retirement savings, but it is feared some are making harmful decisions that leave them poorer or even at risk of running out of money.

It’s not just the big spenders whose plans could go awry. 

Research suggests two fifths of people using freedoms are switching retirement pots into current or savings accounts and letting them get gobbled up by low interest rates and inflation, or becoming liable for unnecessary income tax. 

What are pension drawdown schemes? 

Drawdown schemes allow savers to take sums out of their pension pots while the rest remains invested – usually in a mixture of stocks, bonds, property, cash and so on.

This leaves them exposed to the ups and downs of financial markets during old age.

Whatever capital hasn’t been spent yet could still be growing, but it could also decline depending on what investment decisions are taken.

Pension freedoms have prompted many older savers to shun the safety of annuities, which provide a guaranteed income for life, and are use pension income drawdown to fund retirement instead.

We explain the pros and cons of income drawdown in our 12-step starter’s guide to investing your pension here. 

Money experts warn your cash savings will just lose value, and you can miss out on bigger returns from staying invested in a pension or drawdown scheme.

Now the Financial Conduct Authority has also discovered a third of people who enter drawdown schemes without getting financial advice are sticking their whole pot in cash funds.

People who do this will at least still be protecting their retirement savings from the taxman. But otherwise, using a cash fund within a drawdown scheme comes with all the same disadvantages as putting the money in a bank account – plus the drawdown provider will levy charges.

‘Holding funds in cash may be suited to consumers planning to draw down their entire pot over a short period. But it is highly unlikely to be suited for someone planning to draw down their pot over a longer period,’ says the FCA.

‘We estimate that over half of these consumers are likely to be losing out on income in retirement by holding cash.’

The FCA calculates that drawdown customers could receive 37 per cent more retirement income from their pot every year by investing in a mix of financial assets – such products typically hold stocks, bonds and property – rather than cash.

It based this on an adjusted version of the expected rates of return the FCA uses when making financial projections. Full details are here. 

It assumed an asset mix of 50 per cent equities, 20 per cent government bonds, 20 per cent corporate bonds, 7 per cent property and 3 per cent cash.

‘We considered someone who would draw down their pension pot over 20 years after accessing drawdown. This equates roughly to someone at 65 drawing down until life expectancy but could also reflect a number of other scenarios such as accessing drawdown earlier,’ it said.

‘Clearly the actual amount of income available will depend on a customer’s personal circumstances and rates of return can vary. Nevertheless, this demonstrates the potential harm consumers could suffer if they remain in cash for long periods.’

Check out investment fund options for ultra-cautious savers below.

How do cash funds work? 

Some drawdown plans have cash funds that invest in very short-term, cash-like or equivalent assets. Others will simply stick your cash in a mainstream bank account – you might even be able to choose which one.

You will face costs for keeping your pot in cash via a drawdown product, although charges might be levied in slightly different ways – on the fund itself, or via a general fee for using the scheme.

‘A problem is that people compare a cash fund in a pension with their experiences in a bank,’ says Gary Smith, chartered financial planner at Tilney. ‘The bank has a rate of interest, but the account isn’t subject to charges.

‘What you might find on a cash fund is that interest rates are significantly lower than on a bank account. The cash fund might have 0.5 per cent interest, but charges on the pension fund are 1 per cent.’

‘The other issue is inflation. It’s running at around 2.5 per cent a year. If your cash fund is only making 0.5 per cent you are down 2 per cent in real terms and that’s before taking charges into account.

‘That can impact on the long term viability of a pension fund to meet your income requirements.’

Why are older people using cash funds instead of investing?

The FCA is concerned about people who prefer cash without realising the pitfalls if they don’t invest.

But there are plenty of good and perfectly rational reasons why you might want to keep some or even all of your pension pot in cash funds within a drawdown scheme. 

1) You think markets are about to crash and want to get out, at least temporarily: ‘There is a group of people who might choose to hold cash because they are not confident in the stock markets,’ says Nathan Long, senior pension analyst at Hargreaves Lansdown.

‘It’s not unreasonable that people might think “I want to derisk”. Whether that is a good reason or not we don’t know but it’s a tactical decision to make at a point in time.’

Nathan Long: 'It's not uncommon to have a year or two of income in cash so you are not a forced seller of investments'

Nathan Long: 'It's not uncommon to have a year or two of income in cash so you are not a forced seller of investments'

Nathan Long: ‘It’s not uncommon to have a year or two of income in cash so you are not a forced seller of investments’

2) You want to avoid the risk of ‘pound cost ravaging’: This is a particularly nasty trap for people who invest and take an income from drawdown schemes.

It basically means that when markets fall you suffer the triple whammy of falling capital value of the fund, further depletion due to the income you are taking out, and a drop in future income.

This poses a problem every time markets take a tumble, but is especially dangerous at the start of retirement because investors can rack up big losses and never make them up again if they aren’t careful.

One of the ways to guard against this is to keep one to three years’ worth of potential income in cash within your drawdown scheme, so you can draw on that instead of offloading investments to maintain your usual income in a market downturn.

‘It’s not uncommon to have a year or two of income in cash so you are not a forced seller of investments,’ says Long. ‘If you can take money from the cash, you can choose when you sell your investments.’

Gary Smith of Tilney says: ‘It gives you that buffer so you are not a forced seller if the markets come down.

‘It just gives you that option to lock in gains or carry on drawing down cash until you get to the point there is no more cash and you have to draw down from your investments.’

3) You have upcoming spending plans: If you have a short time horizon, it might be too risky to invest. The rule of thumb is that you should be prepared to tie up your money for at least five years, to ride out the ups and downs of financial markets.

‘You might have a lump sum expenditure due in 12 months time – replacing a car, a child’s wedding,’ says Smith.

‘If it’s in cash you know it’s there. You don’t have to worry about fluctuations in market value.’

Have you invested a pension with no failsafe against falling ill? 

Hundreds of thousands of people are investing in retirement without legal protection against becoming too ill to cope, and exposing loved ones to a costly ordeal to take control of their funds. 

Read more here, and find out how to step in if this happens to a relative here. 

4) You intend to draw down quickly because you have other retirement funds: Some people will spend pots in a short period of time, because they have a bigger final salary pension that starts later, explains Nathan Long.

‘The smaller money purchase pension is there but the plan is just to use it to fund the early years of retirement,’ he says.

5) You are bumping up against the Lifetime allowance: This allowance is the total amount people can put in their pension during their lives and qualify for tax relief. It is currently £1.03million.

The LTA is not a limit on how much can be paid into a pension, as savers can continue paying in above it. However, hefty tax charges will then hit them when they retire.

Any money above this level taken as income incurs an extra 25 per cent charge and as a lump sum it incurs a 55 per cent charge – this comes on top of normal income tax.

This effectively makes paying into a pension above the lifetime allowance uneconomical, as any investment growth above that is heavily penalised, so you might prefer to shift some money into cash funds.

6) You have only a short time to live: ‘If your life expectancy is short and you know when you are going to die, leaving money in cash might be an option as you don’t want to take any risks,’ says Smith. 

Should you reconsider drawdown if you prefer cash to investing?

Pension freedoms have led many older savers to shun the safety of annuities, which provide a guaranteed income for life, and use income drawdown to fund retirement instead.

But many of the people starting drawdown plans now are investing novices, after transferring savings over from their employer’s ‘default’ pension fund.

Gary Smith: 'A problem is that people compare a cash fund in a pension with their experiences in a bank'

Gary Smith: 'A problem is that people compare a cash fund in a pension with their experiences in a bank'

Gary Smith: ‘A problem is that people compare a cash fund in a pension with their experiences in a bank’

Around 90 per cent of workers use the default fund, in effect delegating all decisions to financial professionals, rather than researching or managing investments themselves.

The FCA’s research found many people are focused on getting their 25 per cent tax-free lump at age 55, and are setting up income drawdown plans as a way to do this, without considering how the other 75 per cent of their pot will be invested.

Often they don’t get financial advice on creating an investment portfolio that could see them through retirement, and a sizeable minority in this group are the ones opting to put their whole pots in cash funds, according to the FCA.

Long says the regulator is rightly concerned about people who use cash funds within drawdown schemes, without realising that to preserve income over a long period of time you need to be invested.

‘The main thing is if you are using your pension to provide an income throughout a lifetime you really need to invest that.

‘Otherwise the position is if you sit in cash that won’t deliver a big enough return to provide a decent income. Those people should seriously consider an annuity purchase.’

Long says pension freedoms were launched and drawdown became popular at a time when stock markets were rising and annuity rates were low. But he points out that if there is a market correction and interest rates rise, annuity rates might become more attractive again. 

Where can ultra-cautious savers invest instead of being in cash?

‘A good strategy for those making their first foray into investing, is to start with a multi-asset fund,’ says Ben Seager-Scott, chief investment strategist at Tilney.

‘Multi-asset funds include a number of asset classes such equities, bonds and alternatives. Most wealth management companies, including ourselves, have their own multi-asset funds which cover a number of risk profiles, from cautious to aggressive growth.

How do you find a multi-asset fund?

Read a This is Money guide here. 

‘These are overseen by a team of investment experts which will alter the asset allocation and instrument selection (such as funds, equities and bonds) within the funds to ensure it remains in line with the risk profile and will make any adjustments in line with macroeconomic and market events.’

Seager-Scott says multi-asset funds are also a good option for people who are unsure about stock markets, and want diversification and for someone else to have a strategic overview of their investment.

Another option is to go for an absolute return fund, which is designed to make money under any market conditions, he explains.

‘The aim of the funds is to make a positive return regardless of the direction of the broader stock market, although there can be no definitive promises in investments.

‘Some suggestions in this area include Invesco Perpetual Global Targeted Returns, BlackRock UK Absolute Alpha and Artemis US Absolute Return.’ 




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