“I don’t want any risk in my pension” was a snippet of a conversation overheard in Wren Sterling’s Nottingham office recently. It got us thinking about clients’ belief that you could grow a pension pot without any risk and whether this was a widespread misunderstanding.
When looking at options for funding your retirement, it’s important to understand that your pension pot will be invested – and as with all investments, your capital is at risk. But with the risk that you could lose money, comes the reward – your pension pot can also grow.
Understanding the need for risk in pensions
It could be as simple as understanding the word ‘risk’ in the context of pensions. To some people it sounds ‘risky’ – usually associated with being a bit of a gamble. In this context it is a calculated risk to invest your pension because only by investing in more adventurous funds will it have the opportunity to gain better returns and grow. Naturally, the financial advice industry has to exercise caution in how this is spoken about so people don’t take unnecessary risks, but when we talk about risk, we’re talking about risk and reward.
Having risk exposure in your pension isn’t necessarily a bad thing. In fact, across the world people are beginning to realise that pensioners are likely to live longer and that could mean they will run out of money. In Japan for example, men are expected to live for 15 years longer than their savings will last and women up to 20 years, because they have not historically invested with enough risk for their funds to grow enough.
The important thing is that your fund’s level of risk matches what you are comfortable with and is working towards achieving your long-term retirement goals. Providers offer a range of funds, allowing savers to save in a way that suits their appetite for risk. Those who accept the ‘higher risk’ funds have the potential for higher returns over the long term, but they must also accept a greater likelihood of loss as the performance of these funds can be unpredictable.
Thanks to pension freedom options, more of us are able to use our pension funds flexibly in retirement. Further changes to automatic enrolment rules have meant that the number of private pension schemes is growing but people may not receive the right resources to help them understand what this means for them. When discussing pensions with new clients, we found that some were not aware that their pensions held any risk (particularly with their workplace pensions).
What is a Defined Contribution (DC) pension?
DC pension schemes allow you to build up your pension pot over the course of your working life and then you have a range of choices for how you wish to take the income, on retirement or from age 55. These schemes are also known as ‘money purchase’ schemes.
A percentage of your pay is put into the pension scheme automatically every payday. In most cases, your employer will also contribute, and you may also get tax relief from the government. The value of a member’s DC pension pot depends on the amount of money that has been paid in, the length of time that each contribution has been invested, investment growth over this period and the level of charges.
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The value of investments can go down as well as up. Investors may get back less than the amount invested.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means tested benefits.
Accessing pension benefits is not suitable for everyone. You should seek advice to understand your options at retirement.