Get to know the four risks that could derail your retirement plans

When the time comes to access your retirement income, you’ll have new challenges to contend with.

The wide-ranging pension reforms that came into force in April 2015 were all about giving people greater flexibility with their retirement income.

There was a flipside to that promise, however. In giving individual investors more freedom, the government also gave them more responsibility.

In the lead up to retirement, you’ll likely be saving and investing regularly and building up your wealth. But in retirement, you’ll be relying on this pot without continuing to accumulate new assets. You’re therefore vulnerable to a number of risks that ordinarily might be less of a concern.

“Once you move into retirement and start to take an income from your pension pot, you’re exposed to all of these risks,” says Tony Clark, Head of Retirement Marketing at St. James’s Place Wealth Management.

The good news is that there are various ways of avoiding or mitigating them, and financial advisers can help you monitor, adjust and maintain your retirement strategy with the risks in mind.

Here we focus on four risks that are particularly pertinent to drawing an income if you remain invested in retirement: sequencing risk, pound-cost ravaging, inflation risk and longevity risk.

1. Sequencing risk
What does it mean?
The timing of withdrawals from your drawdown fund – namely whether they occur during a weak or strong market – can affect the overall value of your retirement pot.

Another way of explaining it is that taking money from your pension during a market downturn is more costly than withdrawing during a strong market. In particular, poor returns early on in retirement can make it more difficult to recover from losses. The smaller your fund becomes, the greater the proportion of it that’s needed to provide the same level of income.

What should you look out for?
Market volatility in the early stages of retirement should set the alarm bells ringing if you’re taking income from your drawdown fund.

What can you do about it?
Perhaps drawing from other sources, or managing your income levels during market volatility early on, will help to protect the fund. Sequencing risk is only an issue when you’re taking income from the fund.

2. Pound-cost ravaging
What does it mean?
Although this is a component of sequencing risk, it can be a problem at any point in retirement. If you continue to withdraw the same level of income during market downturns, when your fund may be falling in value, you’ll need to cash in more of your pot to maintain your income over the longer term.

“It’s very important to seek advice in this case, as your fund will need to work very hard to bounce back from the effect of drawing from it in a falling market,” says Clark. “You’re creating an issue that you could be paying for over a good few years.”

What should you look out for?
As with sequencing risk, it’s an issue if you’re taking income from a fund that’s being negatively affected by market volatility.

What can you do about it?
Falling markets should serve as a reminder to review the level of income you’re taking from your pot and work with an adviser to adjust where necessary.

3. Inflation risk
What does it mean?
Inflation – how quickly the prices of goods and services are rising – can be doubly damaging in retirement, because it can reduce the value of your capital as well as the purchasing power of your income. When investing for retirement, you have time on your side to tackle the effects of inflation. You don’t have that luxury once in retirement.

What should you look out for?
You can’t directly affect the rate of inflation, but it’s worth noting whether it’s rising – and how quickly – so you can review your future income needs.

What can you do about it?
Assets such as equities tend to beat inflation over time, so maintaining at least some exposure can mitigate the impact of rising prices on capital value.

4. Longevity risk
What does it mean?
People in their 50s and 60s underestimate their chances of survival to age 75 by about 20 percentage points and to 85 by around 5 to 10 percentage points, according to the Institute for Fiscal Studies. In other words, men born in the 1940s who were interviewed at age 65 reported a 65% chance of making it to age 75, while the official estimate was 83%.1 Underestimating it by even a year can seriously hurt your retirement plans.

What should you look out for?
Think about the probability of surviving beyond a certain age, rather than average life expectancy statistics. If your life expectancy is estimated at 85, for example, that’s just the 50-50 point; you have a very good chance of living even longer.

What can you do about it?
Don’t underestimate how long you might live. An adviser can use their knowledge of cashflow modelling to ensure that your retirement income strategy accounts for the potential impact of longevity on your income and capital.

All of these risks can pose a very real danger to retirement incomes, but investors are often unaware of them until it’s too late. If there’s a single step you can take to protect yourself against them, it’s to take professional financial advice.

“Advisers will be cognisant of what’s going on in the market,” says Clark. “They can look at your strategy in a broader sense, taking into account other assets and sources of income you can draw from, and put in place a plan to mitigate the various risks.”

If you’d like to understand more about how risks could affect your retirement income strategy, McGrady Financial Services Ltd are here to help.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and the value may fall as well as rise. You may get back less than the amount invested.

1 Subjective expectations of survival and economic behaviour, Institute for Fiscal Studies, 2018