The role of cash in retirement plans

With interest rates at rock bottom, having savings in cash to fund your retirement might seem like a poor idea.  After all, savings rates are so low that money is likely to lose value in real terms when you store it in the bank.

However, the way that stock markets around the world reacted to the coronavirus crisis illustrates why it is important to have a cash cushion.

Most of us will fund our retirement by taking money out of a pension that is invested in the stock market and other assets with values that move up and down. Whether we withdraw all of that money immediately - either to purchase an annuity or to put it into an instant access account - or withdraw it in tranches, we are at the mercy of stock market volatility in terms of the value of those funds.

Those retiring at the peak of the coronavirus crisis will have felt this weakness particularly acutely. Stock markets around the world fell sharply in February and March, before bouncing back. Those who needed to crystallise savings invested for retirement in March 2020 could have missed out on thousands of pounds worth of spending money for their old age, simply because they were unable to wait for markets to recover.

Building a buffer

Those with cash savings to tide them over could afford to wait longer to crystallise their investments, leaving them with more money in the long run, because they could ride out the storm.

That is one reason why it is important for all savers to ensure that they have enough easily-accessible money to help them to manage retirement spending in the most effective way possible.

Cash savings can also prevent  those approaching retirement from dipping into their pension at the wrong time because of unexpected emergency costs.

While many experts suggest holding between three and six months worth of outgoings in cash, for those coming up to retirement it may be prudent to increase cash allocations. This will ensure that there is sufficient available cash to ensure flexibility in difficult times without compromising retirement savings. 

This money should be somewhere where it can be accessed easily if the market falls, perhaps an easy access account or ISA. 

Everyone has a £20,000 ISA limit every year, and money within an ISA can earn interest without being taxed. It is possible to hold cash in a pension, but rates are usually very low and it is important to understand the restrictions about when this money can be accessed. An adviser can help you to understand how quickly cash can be taken from a pension if it is needed.

Other strategies to help weather storms

While having cash readily available is one way to help those planning retirement to ensure that their lifetime savings are protected from market downturns, it is also important to consider the overall risk profile of the portfolio. 

Many pension funds choose to move individual’s pension savings into lower-risk assets such as bonds, rather than equities, as they approach retirement age. This process is known as ‘lifestyling’ and is  also designed to smooth out volatility in an individual’s portfolio before retirement.

Even lower risk assets are likely to perform better than cash savings in the current market, so it is important to get the balance right to ensure individual peace of mind as well as maximum flexibility, at the same time as ensuring that money is working as hard as possible.

Everyone’s risk tolerance and circumstances are different, so there is no one-size-fits-all cash cushion for everyone approaching retirement, but it is worth individuals taking a lesson from the Covid crisis to protect their future wealth.