What does coronavirus mean for your retirement plans?

If you are approaching retirement, this is a worrying time, given market falls. We explain how you can help pension pots to recover, whether you should delay taking your pension, and the do’s and don’ts of drawing pension income.

Markets have dropped over 30% since mid-February, but the experts are in no doubt: despite the enormity of the Covid-19 crisis, what goes down will eventually come back up. Nonetheless, for anyone approaching retirement with a defined contribution (DC) pension, such as the 10 million auto-enrolled in workplace schemes and the million people who buy self-invested personal pensions (Sipps) every year, these are worrying times.

The situation raises several questions for those on the cusp of retirement. First, what can be done to help pension pots recover in the coming months and years? Second, what are the financial options if you’re prepared to delay touching your pension for a while? And third, if you can’t get by without drawing pension income, what should you bear in mind?

- Withdrawing income from a Sipp in a bear market: dos and don'ts
- Six ways to powercharge a small pension pot
- More retirement planning articles

The table below shows how long stock markets have taken to recoup their losses after previous crises. While it has varied a great deal, the average recovery time is 648 days, and the economy typically bounces back in around one year. The longest recovery period was four years, after the 2007 credit crunch. 

FTSE All-Share: crashes and recovery time

Source: Refinitiv Data

“The uncertainty gripping equity markets since the coronavirus outbreak hit means millions have been nursing short-term losses of 30% or more,” says Tom Selby, senior analyst at AJ Bell. “However, most people will be invested in a mix of funds from around the world, as well as lower-risk assets such bonds and cash. This diversification will have helped mitigate the impact of the recent sell-off, although most will still be wearing significant losses as a result of the crisis.”

In fact, for people in workplace pensions approaching retirement, there may be some good news. You may be in a defined contribution (DC) or investment-based pension that has de-risked into bonds and cash in recent years, something often done on an automatic basis to protect employees from heavy stock market losses just before retirement, and you may even have seen an investment gain through this turmoil. However, staying invested in bonds in the longer term does not make sense as gilts are currently overpriced, so if this is the case it may make sense to change your underlying fund to one that is broadly diversified.

Pension recovery

In the remaining time before you retire, what can be done to help your funds recover over the medium term?

The biggest mistake you can make right now is to lose confidence and sell investments that have slumped, unless some new, salient information emerges about your particular share or fund. Selling would simply crystallise your losses and potentially put you out of the market when the recovery happens, which often occurs in fits and starts. To put that into context, the S&P 500 index has returned around 6% a year on average over the last 20 years, but if you missed the best 20 days in the market over that period, your average annual return would shrink to 0.1%. 

Another danger is in attempting to time the markets, particularly calling the bottom of the market prematurely. In practice, once the market starts to show some stability, investors are often tempted to believe it marks the low-point; but if you look at the last six major crashes on a FTSE 100 chart, investors would have lost out on 38%, on average, if they had jumped the gun and bought into the market at the midpoint (between the highest and lowest points) rather than at the very bottom.

However, if you are able to boost your regular contributions to your pension right now, you can make your money work much harder for you in the run-up to retirement, because you will benefit from pound cost averaging. Regular contributions have the effect of buying more shares when the price is lower and fewer shares when the price is higher. In a falling or volatile market, this will 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.

Even if you are in a final salary pension scheme, your employer probably offers an additional voluntary contributions scheme to top up your pension, where you can make extra regular contributions to your final salary arrangement, based on a panel of investment funds.

For those who are wary about current stock markets, remember the carry forward rules - if you don't invest your full pension allowance in one tax year, you can carry it over to the next. Russ Mould, investment director at AJ Bell, also recommends the additional downside protection available from certain funds or investment trusts whose remit is to protect investors’ money, such as the Personal Assets investment trust, managed by Sebastian Lyon of Troy Asset Management. This operates with an absolute return mindset and offers a diversified portfolio that includes quality equities such as Microsoft, Nestlé and Unilever, short-dated government bonds, cash and gold, providing an instantly diversified portfolio in one holding.

One important measure is to keep a chunk of your pension in cash, ideally equivalent to two or three years of income. This will protect the downside, providing a source of income if markets fall again when you’re about to access your fund. It will prevent you having to sell units of investments that have fallen in value, in order to draw the income you need, and could also provide the scope for you to step in and pick up bargains when the time is right.

Pension income strategies

If you plan to go ahead and access your pension pot before markets have recovered, there are various precautions and tactics worth bearing in mind. A simple strategy is to draw only the natural yield from your investments, as this ensures you never have to sell investments at depressed prices to pay yourself income. But this may be more difficult than usual, as companies have already been cutting their dividends and many more will be axed over the next year.

It’s crucial to recognise, however, that taking too much out of a Sipp in the months ahead, when the crash has eroded the value of your pension pot, could have dreadful consequences for its long-term sustainability. It’s dangerous either to take a fixed sum or to stick to an over-generous percentage from a declining pot: either way, in order to pay yourself that income you’ll be drawing on capital right at the start of your retirement, reducing the number of units in your investment and making it much harder for the fund subsequently to recover its original value.

“Let’s assume someone is taking 5% of their initial fund value as a retirement income, rising by 2% a year in line with the Bank of England’s inflation target,” says Selby. “If they suffered a 20% hit on their underlying investments in the first year in drawdown and then 4% growth thereafter they could see their pension pot run out after 18 years – three years sooner than if they suffered the hit 10 years into retirement (and 4% growth otherwise). By contrast, someone who enjoys 4% growth throughout their retirement could take the same income for 25 years.”

There are other considerations to bear in mind once you start accessing your pension pot. First, savers who face short-term cashflow problems and make additional withdrawals from their Sipps are likely to face HMRC “emergency tax” on such withdrawals, which means they may receive much less cash than expected and then have to wait to claim back overpaid tax, explains Steve Webb, partner at Lane Clark & Peacock. This is because HMRC makes the Sipp provider tax investors as though they plan to withdraw this large amount every month throughout the tax year.

Second, if you take taxable cash from a DC pot, in most cases this will trigger the money purchase annual allowance (MPAA) of £4,000, which 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) with the benefit of tax relief, rather than the standard annual allowance of £40,000.

Some pension investors may be able to get around this if they have small pensions worth £10,000 or less, as up to three such “small pots” can be cashed in without triggering the MPAA. With each cash lump sum payment you’ll receive 25% tax free, and the remaining 75% is taxed as income.

Nonetheless, for most of those coming up to retirement, a Sipp is preferable to the bleak annuity rates currently on offer. “If you move into shares in order to take an income from a drawdown plan, you should expect a continued bumpy ride for months and maybe years to come,” says Tom McPhail, head of policy at Hargreaves Lansdown. “However if you lock into an annuity now, particularly if you are only in your late 50s or early 60s, you’ll get a miserly rate.”

“For a 55-year-old buying even a single life level annuity, the best rate currently is only £3,612 a year; if you’re 65 and looking for an inflation-linked annuity, you’ll only get £2,977 a year. For many people, accepting the uncertainty of the equity markets and staying invested via drawdown, at least until the current turmoil is over and perhaps until their 70s, is likely to make more sense.”

Finally, there is one surprise silver lining for investors approaching retirement and worried that they will breach the Lifetime Allowance (LTA), which is £1.073 million in the 2020/21 tax year. Now might be a good moment to shift your pension fund into drawdown, because this will trigger a so-called benefit crystallisation event and your pot will be tested against the LTA at a time when you’re less likely to breach the limit as markets have fallen. You may thus be able to avoid or reduce the tax penalty. There are complications to this, however, in that you would trigger the MPAA, which could restrict your capacity to fund your pension in future.

Could you put off drawing your pension?

Delay your retirement: under the Equality Act 2010, employers cannot force employees to retire unless it can be objectively justified, for example, posts in the emergency services that require a level of physical fitness.  

Phasing your retirement, perhaps by working part-time, has the advantage of acclimatising you to the real thing. Every employee has the statutory right to request a more flexible work patternafter 26 weeks of employment. That might mean home-working, part time, flexitime or job sharing.

Other ways to earn: it may be possible to retire but delay drawing your pension by supplementing your income through freelance activities. Perhaps you have skills and experience that would be in demand on a consultancy basis. You might apply, for example, for a non-executive director post, which typically require one or two days’ work a month and could also enable you to continue being involved in your specialist area at a senior level.

Maybe you want to do something completely different. You may have picked up secondary skills and knowledge that could be used in a new capacity, for example as a tutor, adviser or book-keeper. If you have experience with children, for instance, there are youth activity organisations such as the National Citizenship Service, which offer chunks of work, often residential, for three or four weeks in school holidays.

Other sources of income: you may be able to cobble together a smorgasbord of income sources – for example using income from any final salary pensions you may have; plus Isa income; savings capital; cash from “small pot” pensions (see above); or even rental income (the government’s Rent a Room scheme allows you to earn up to £7,500 a year tax-free by renting out a room in your house).

Alternatively, you may have parents who might like to help out and at the same time reduce their future liability to inheritance tax. Each person can give away £3,000 worth of gifts in a tax year without it being added to the value of their estate. Any unused annual exemption can be carried forward to the next year, so if both your parents are alive and willing, they could give you £12,000 between them.

People who have an endowment plan nearing maturation, for example to back a mortgage, can often borrow against this at a low rate because there is negligible risk to the lender. The loan could subsequently be repaid when you receive the tax-free cash from your pension lump sum.