Securing your pension fund as you get
close to retirement
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If you invest in equities, property or a managed fund then it is important
that you consider changing your investment strategy as you get nearer to
retirement. Remember when you reach retirement you will probably take some
percentage of your fund (normally around 25%) as cash and the remainder must be
turned into a pension payable for life. If you do not change your investment
strategy you are running the risk of a significant drop in the value of your
pension fund close to retirement, just when you can afford it least! What most
advisers suggest is that you slowly move your fund into bond funds (75%) and
cash funds (25%), and here's why....
When you come to convert your fund into a pension you must buy what is called
an annuity. Annuities are sold by life insurance companies. When a life
insurance company comes to decide how much pension to provide you with in return
for your fund they will consider the investment return available on bonds. This
is because life insurers must measure their financial health by reference to
bonds and therefore will take your pot of money and buy a load of bonds with it.
So if when you retire the price of bonds is high you will get less pension for
your money. If when you retire the price of bonds is low you will get more.
Therefore to protect your expected pension income from dropping suddenly near
to retirement you move out of equities and into bonds and cash. Imagine you are
close to retirement and you hold 75% of your fund in bonds and 25% in cash. If
the price of annuities rises it does not matter because you will have an
increase in your pension fund to compensate. The downside is that if the cost of
annuities drops so will your fund. Therefore by moving into bonds and cash close
to retirement you immunise yourself against changes in the cost of annuities.
Moving slowly over a period of 5-10 years is the generally recommended
approach. 5 years is more risky than 10 obviously but 10 years may be considered
too long a period as it reduces the amount of time you are invested in higher
returning assets such as equities. If you wanted to switch over a 10 year period
you could move 15% into bonds every two years and 5.0% into cash. After 10 years
you would be entirely invested in bonds and cash.
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"Lifestyle" funds
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If you are invested in a
"lifestyle" fund this form of switching into bonds is done
automatically and this is why many pensions provide this as a
default option. However if you do invest in a lifestyle fund you
cannot take control of this switching yourself. Whether this is a
good or bad thing depends upon whether you would rather have this
managed for you or take control of these decisions yourself.
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