I am 63 and, because I am hoping to retire in the next two years, a lot of my pension is held in a cash fund.
However, the value is steadily decreasing due to charges and inflation. What options do I have to avoid this?
– Anon, Co Kildare
The low-interest rate environment of the past few years has posed many challenges to people approaching retirement. Typically, at this stage you will have your eye on taking 25 per cent or more of your pension as a tax-free lump sum at retirement. The last thing you want is for the value of your lump sum to be hit if investment markets fall just before you plan to draw down.
This is why many people choose to keep a large amount of their pension pot in cash in the run-up to retirement.
Inflation, fees, and negative growth
Yet there is an obvious downside. Not only has cash held in your pension failed to grow, it has almost certainly fallen in value.
The effect of inflation and fees is well known. What is less obvious is the performance of your cash fund. For example, Irish Life’s global cash fund has averaged losses of 1.1 per cent a year over the past five years.
The good news is that there are alternatives. Much depends on your timescale, tolerance for a fall and willingness to add complexity to your retirement financial planning.
1. Assess your timescale
If you intend to retire with a €250,000 fund in two years’ time, the costs of holding cash may be low compared with the risks of investing the money.
If a quarter of your fund is in cash, for example, the cost over two years might be something such as €1,300. You might decide this is a small price to pay for certainty on a decent portion of your pension pot.
2. Consider a low-volatility portfolio
On the other hand, if your fund was larger and retirement half a decade away, the missed opportunities of investment growth and the compounding that comes with it would be greater if you stayed in cash. This is not to say you should bet the lot on speculative stocks.
You can use funds with some growth prospects such as inflation-linked bonds and value-driven equities.
3. Split your pension into different accounts
It is also possible to manage the timing of your lump sum. You could split your pension into different accounts and draw them down at various times.
This alternative involves a little more planning. But it could let you take a smaller tax-free cash lump sum and retirement income now, leaving the bulk of your pension invested in non-cash assets tax-free for longer.
This blog is adapted from a Moneycube article which appeared in the Sunday Times on 8 August 2021.