DrawdownMar 25 2020

How a global stock market crash affects your pension 

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How a global stock market crash affects your pension 

February 24, also dubbed ‘New Black Monday’ and ‘carnage’ saw major stock markets crash after Saudi Arabia lowered the price of crude oil in an attempt to penalise Russia for refusing to limit oil supply in efforts to cushion the impact of the coronavirus outbreak. 

On March 16, fears about the Covid-19 pandemic sent the Dow Jones plunging 2,997 points, or 12.9 per cent. The S&P 500 shed 12 per cent, its worst day since 1987.

While the obvious impact is on the wider economy, the recent developments have ramifications for the pension pots of many individuals.

Drawdown

Those who are in defined benefit pension schemes have less to worry about, as DB schemes offer just that: a defined benefit. The investment risk for the investor is carried by the scheme, so the pensioner does not lose out, and DB schemes often have gold-plated guarantees for pensioners. This is compared with defined contribution schemes, where the individual carries the investment risk and if markets turn against them - too bad. 

Data published by HM Revenue & Customs showed £2.75bn was withdrawn from pensions flexibly in the second quarter of 2019, up from £2.27bn in the same period in 2018.

Key Points

  • There have been major falls on the stock markets.
  • Concerns exist among investors about the falls they have experienced.
  • One option is to have a phased drawdown.

Stock market volatility can reduce returns in drawdown. So how are defined contribution schemes affected?

Mihir Kapadia, chief executive of Sun Global Investments, says: “The volatile markets and sharp losses will have had a significant knock-on effect on pension schemes. Since the start of the outbreak, losses have hit schemes by as much as 10 per cent and are likely to worsen as the virus spreads.”

Several commentators highlight that the market weakness is likely to see significantly reduced DC pension pots and will impact the amount retirees should withdraw. 

DC schemes

Ricky Chan, chartered financial planner and director at IFS Wealth and Pensions, cautions: “For those in the growth or accumulation stage of saving for retirement — generally speaking, those below age 60 — this could mean sharp falls in their pension funds as the investment strategy is typically largely weighted towards equity content.” 

He adds: “It would be wise to consider reducing or deferring withdrawals from funds that have suffered significant falls in value in order to mitigate the damage. Or perhaps there are other resources the client can rely on in the short term; for example, funds on deposit or lower-risk investments that haven’t suffered steep falls.”

Mr Kapadia urges pensioners against withdrawing large sums amid the current market landscape: “It is important that people avoid panicking and withdrawing large sums while the markets remain as they are.

“This is because they will be at a high risk of reducing overall pot sizes, which will impact the savings generated by them when they could have easily been brought back once the pandemic has calmed down.”

Alistair Jones, client strategy director at SEI Institutional Group, says it is common for members with DC schemes to panic quickly. 

But he points out that significant losses are only seen for pensioners who have long-term time horizons, meaning they have a long time until their savings are finally drawn down. This is due to the fact that their schemes often have higher allocations to riskier assets such as equities. 

Mr Jones adds: “The good news for these savers is that the entry point to keep making their regular savings is now significantly cheaper. Higher returns can be expected on those savings that are yet to be made.”

Annuities 

Various central banks have engaged in co-ordinated monetary policy efforts to soothe markets, including the Bank of England reducing the main bank rate twice in a matter of weeks, taking it down to 0.1 per cent on March 19.

Interest rates have already been historically low, and this further cut could undermine the attractiveness of annuities, experts claim. 

Mr Jones says: “Annuity rates have been relatively unattractive for savers over the past decade given the low interest rate environment. Following the recent emergency base rate cuts by the Federal Reserve and the BoE, annuities are looking even less appealing now.”

If interest rates are high when individuals buy an annuity, then annuity payments will be higher and the converse applies for when interest rates fall. This is because financial institutions can earn more by investing the money. 

But Mr Kapadia still sees some value in annuities despite “their bad reputation in recent times”. 

He says: “There are [still] opportunities to use part of your pension to buy an annuity while the rest is left in drawdown. As there is no annual contribution and large sums can be deposited, this could be an option to help keep stability during this period.”

He also expects to see a rise in one-off lump sums, but the total amount of the lump sums taken out will be lower than the maximum 25 per cent allowed. 

“As the first 25 per cent of any withdrawal is tax-free, this will help provide a short-term solution. However, investors must still approach with caution and avoid hasty decisions, which will see them lose more in the long run,” Mr Kapadia adds. 

Adrian Lowcock, head of personal investing at Willis Owen, points out one option is to have a phased drawdown alongside a phased annuity, which involves purchasing an annuity and another one a year later, phasing out the process. 

The return of cash?

Experts stress that pensions are long-term savings, and therefore in most cases the best thing for clients to do is remain invested, assuming they are not about to retire anytime soon. 

Many also stress that individuals should hold some cash, despite the low interest rates. “If you are three years away from retirement, what do you do?” asks Mr Lowcock. 

He urges clients to keep one to two years of buffer cash on average. “With a cash buffer you can smooth out the volatility, if you have two to three years of income for most market falls that can be a lot of cash,” he adds. 

This view is echoed by several others. 

Mr Kapadia says: “Savers not needing the cash urgently will be better off putting some money away into a one or two-year fixed rate product, as it can take as much as three months for it to pass on. They will help keep cash from being affected by more interest rate cuts while guaranteeing the level of interest paid.”

He adds: “However, it is important to understand that pension pots have done considerably well in the past five years or so, meaning that although this is a hard hit [area], schemes should still be better off over the long term.”

Saloni Sardana is features writer at FTAdviser and Financial Adviser