In recent weeks, one of the consequences of the coronavirus pandemic has been volatility in global stock markets.
Many of the major indices around the world have fallen in value, meaning that, if you have equity-based pensions or investments, your fund may have taken something of a hit in recent weeks.
This fall may have led you to review your retirement planning. Perhaps you are even considering making changes in the light of recent events? Before you do, here’s a guide to coronavirus and retirement and what you need to know.
What hasn’t changed?
Despite the recent stock market volatility, not all of your retirement income provision may have been significantly affected:
- State Pension – this is unaffected by volatility in the stock market, so you can still expect to receive any State Pension you are entitled to
- Defined Benefit pension – if you have any Defined Benefit/Final Salary pensions then any investment risk is borne by the sponsoring employer. Your pension is based on a percentage of your final salary multiplied by the number of years you have been in the scheme (this ‘accrual rate’ is usually 1/60th, 1/80th or 1/100th of your final/average salary). This should not change even in light of recent events. Find out more about Final Salary pensions in our guide.
The impact of coronavirus on your pension
As of 15 April 2020, the MSCI World Index – a weighted global stock index featuring 1,643 constituents across 23 developed markets, including the UK, US, Germany and Japan – had fallen by around 17% since 1 January.
At its worst point, global shares had fallen by around 30%. However, some markets have recovered slightly since mid-March when both the FTSE and Dow Jones experienced their steepest one-day falls since the 1980s.
One of the biggest mistakes you can make right now is to sell investments that have fallen in value unless some new, salient information emerges about your particular share or fund. Selling now turns a paper loss into an actual loss and could result in you being out of the market when the recovery starts to happen.
The chart below shows that spending time out of the markets can have a significant effect on your long-term returns.
Source: Fidelity
If you had missed just the five best investment days between the start of 1980 and the end of 2018, you would have sacrificed USD232,550 in returns. That is around GBP187,000/AUD369,250 in lost growth for being out of the market for just five days.
If you’d been out of the market for the best 30 days, you would have missed growth of USD534,497 (around GBP430,000/AUD848,700).
Losses can be painful. However, history shows us that, if we are patient, markets tend to recover.
Here’s the annualised returns of the MSCI World Index over one, three, five and ten years, and since its launch at the end of 1987.
Source: MSCI
Over the last decade, the index shows an annualised return of 9.36%. Between 31 December 1987 and 31 December 2019, the annualised return of global equities was 7.72%.
Again, this was despite some years where the index showed negative returns. Here’s the annual performance of the MSCI World Index since 2006.
Source: MSCI
You will see that there have been three years of negative returns during this period – in 2008, 2011 and 2018. However, as a whole, the index has risen since 2006 (and, indeed, since its launch in 1987).
A quick note on diversification
When looking at the performance of stock markets, it’s also important to remember that falls in the value of the Dow Jones or FTSE 100 are typically not the same as the fall in the value of your portfolio.
Our clients typically have diverse portfolios that include exposure to other asset classes, for precisely this type of situation.
In addition, if you are approaching retirement and you have a Defined Contribution (DC) or investment-based pension, it’s possible that your investments have already been ‘lifestyled’. Often, in the years immediately before retirement, your fund is de-risked into bonds and cash in order to protect employees from heavy stock market losses just before they retire.
The conclusion? Your pension fund may not have fallen in value by as much as you think.
How to boost your retirement income
Being patient and waiting for markets to recover in the long term is one way of ensuring your retirement plans aren’t blown off track.
If you are concerned, or perhaps you don’t have as many years left until you retire, boosting your contributions now might help. One of the reasons is that making regular contributions to a pension means you benefit from ‘pound-cost averaging’.
Regular contributions have the effect of buying more shares/units in a fund when the price is lower and fewer shares/units when the price is higher. In a falling or volatile market, this will typically give you more units at a lower average purchase price than if you simply invested the full lump sum at the beginning of the period.
What if I need to access my pension pot?
Of course, there will be savers who need to access their pension pots in the wake of the coronavirus pandemic.
If you are facing a short-term cashflow problem and you want to make withdrawals from your pension pot, beware that such withdrawals could see you paying ‘emergency tax’ and receiving less than you think.
HMRC often assumes that such withdrawals are going to be regular throughout the year and so taxes them accordingly. While you can reclaim any overpaid tax, in the short term it may mean you get less than you expect.
Second, if you take taxable cash from a Defined Contribution pension, you are likely to trigger the Money Purchase Annual Allowance (MPAA) of £4,000. This means that, in future, when you are in a position to start working and building up your pension again, you may find you can put in only £4,000 per year in total (including employer contributions, tax relief, etc) and benefit from tax relief, rather than the standard Annual Allowance of £40,000.
Some pension investors may be able to get around this if you have small pensions worth £10,000 or less, as up to three such “small pots” can be cashed in without triggering the MPAA. Here, with each cash lump sum payment, you’ll receive 25% tax-free, and the remaining 75% is taxed as income.
Get in touch
If you’re worried about your pension in light of recent stock market volatility, we can help. We’re Chartered financial planners and pension specialists and can help you to plan for your retirement.
Please get in touch or call (01372) 724 249.
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
