How market drops could affect your pension

When markets fall, a simple solution for most pension investors can be to ride it out. Historically, prices have recovered, and if your plans for retirement are still far away you likely have time to wait.

But when you’re in the final years before retiring or have already retired and started accessing your pension, a tumble in your investments can feel much more worrying.

It’s key to remember that a market drop is not something that’s out of the ordinary. So just like earlier on in your investment strategy, it’s not time to panic.

If we look back at recent significant market turmoil we can see that people tend to delay taking money out of their pension during periods of downturn, likely to avoid cashing in their investments when markets have dropped, locking in the loss.

Data from the regulator, the Financial Conduct Authority (FCA), shows that when the market crashed during the Covid-19 pandemic, people cashing in their pensions for the first time dropped about 13% from the third quarter of 2019 to the third quarter of 2020. Similarly, those opting for drawdown pension plans dropped over 25% in that period. But as markets shot up in 2023, so did those accessing their pensions. From the first quarter of 2023 to the third quarter, people cashing in their pension for the first time grew by 16%.

Assessing your situation

If the market is experiencing a decline, it can be an important moment to assess your current financial situation. This might include looking at how far you are into your retirement, and how much you are planning to spend, or have been spending already.

Some pensioners base their income off the ‘4% rule’, meaning a withdrawal of 4% per year from your pension pot, adjusted each year to match inflation. This isn’t the ideal system for every person but can act as a starting point. Looking at how long different withdrawal levels will last is key to knowing how long your funds will last through retirement.

Depending on your investments, you also may be benefitting from natural yield that can be used for income. Instead of withdrawing funds from your holdings throughout your retirement, natural yield creates income through dividend payments and bond coupons. Even if you’re not completely living off these payments, it can be a nice cushion.

Assessing your different ‘baskets’ of money, such as how much is in cash, bonds, or equities, can also help during times of market volatility. While cash investments will typically be stable during market downturns, your equity and bond holdings may have taken a bit more of a ride. While bonds are typically less volatile, recent years have shown some more extreme changes in these markets as well, so it’s helpful to see where you stand and how much risk you are currently taking in your portfolio.

Taking action

Even if you are nearing retirement, your best bet may still be no action at all, because you could still have 30 years of retirement ahead. And while you may be making withdrawals during this time, you could still have a long horizon for investments to recover.

Before making investment changes, you also may want to consider personal changes you can make to not outspend your retirement savings. Cutting back on costs is one way to reduce the withdrawals you need to take from your pension during periods of market downturn. This could mean swapping your Waitrose shop for Sainsbury's or turning one of your destination holiday plans into a staycation.

But if you don’t want to change your lifestyle or have already made cutbacks, you could also look at ways to generate extra income outside the market. This could mean selling something or trying your hand at a part-time job.

If you do need to withdraw from your retirement while the market is down to provide funds to live on, you may want to think about which portion to draw from. Funds stored in cash will have maintained their value, and if you have a significant amount to live on in this pot, you may be able to leave your other investments alone to regain value.

Looking towards the future

A market dip can serve as a good reminder to look at what risk you’re taking in your investment portfolio. You may not have needed to adjust your strategy, but it’s useful to check in with whether you’re comfortable with the risk you’re taking or whether you’d want to dial it down in the future (or even increase it).

It can make sense to hold off on pension access in a downturn. But people can sometimes align their spending habits with how the market is performing. A stable budget can help avoid having to make dramatic changes based on the upturns and downturns, and let you continue your plans regardless of market noise.