If you intend to use your pension to provide yourself with an income for life in retirement, or if you will primarily be using it to provide tax free cash, then it may be worth reducing your pension fund’s exposure to risk over the last seven to ten years before retirement.
Avoiding market shocks
When retirement is distant, a medium or high-risk approach to investing your pension makes sense. You have no imminent use for the money, and if markets fall you have time to wait for recovery. A drop can even work in your favour: it means any new pension contributions you make can take advantage of lower market prices.
As you enter your last ten years or so to retirement, however, you will have less scope to ride out stock market peaks and troughs. To give an example, in 2008, the average medium-high risk Managed Pension Fund fell in value by 35%. While 2009 saw much of the loss clawed back as Managed Funds gained 21%, this would have been of little consolation to anyone retiring at the end of 2008 who had not taken steps to reduce their risk beforehand. By reducing your exposure to risk as you draw closer to retirement, much of your pension fund’s value can be protected.
It is likely that your pension will provide access to a “Lifestyle Fund”. This is often the default fund, into which your contributions go if you do not explicitly pick a fund.
Different lifestyle funds have different features, but typical characteristics are as follows:
- The fund takes note of your normal retirement age, as specified for your pension scheme if you are in an employee pension plan or as specified on your application form for a PRSA or personal pension
- When retirement is distant, a relatively high level of risk is taken
- In a designated period before retirement, which can be as little as five years or as many as twenty years, your fund will be gradually moved out of higher risk assets such as equities and into lower risk assets such as cash or government bonds
- As the transition takes place, your exposure to market fluctuations steadily reduces
Steps to consider
If you are approaching retirement, you might wish to consider taking one of the following steps:
- Investigate whether your pension is invested in a lifestyle fund
- Move your fund directly into a cash and/or government bond fund if retirement is very close – say within two years
- Move your fund gradually into a cash and/or government bond fund if retirement is 7-10 years away
- Leave your fund invested in a medium or high-risk manner. This course may be suitable if you intend to transfer most of your pension to an ARF at retirement, or if you have made sufficient provision so that you will not be dependent on your pension for retirement income