The best and worst years to retire – and how to protect your income

Did you retire in 2000? If so, commiserations – you left work in the worst year possible in at least two decades, according to new research.

Your parents or grandparents may have enjoyed generous defined benefit pensions in retirement, safe in the knowledge their incomes would always be there however long they lived for. But these pensions are now mostly extinct – today, most retirees have to use a mix of good timing and clever investment strategies to ensure their pension pots do not run out of money. 

Most people now have defined contribution pensions, which are invested in a mix of stocks and bonds. This means the value of your pension is always fluctuating, and bad timing can shave tens of thousands off the final value of your pot. 

How does timing affect my pension?

An invested pension will be affected by its “sequence of returns” – an investment theory which suggests any losses your pension makes early in your retirement saving journey can have a particularly harmful impact on the final value of your pot, even if those losses are followed by good returns. 

For example, consider the chart below, which looks at market data going back around three decades. In each year, someone new has a £100,000 pension that is 60pc invested in stocks and 40pc invested in bonds. The year in question is when they begin to withdraw an income from their pension at a rate of 4pc, increasing this amount each year by 2pc to help their spending keep up with inflation. 

The chart shows what these pensions would look like after 10 years. In the worst case scenario where someone began withdrawals in 2000, the pension was worth £81,000 by 2010 – almost £100,000 lower than in the best case scenario in 2003, which ended at £177,000 in 2013. 

Ed Monk, of the broker Fidelity, said: “A little knowledge of stock market history reveals why. The ‘dot com’ crash saw stock markets fall sharply from March 2000 until the end of 2002. 

“A retirement fund that had begun withdrawals in January 2000 will have been badly affected, while a fund beginning withdrawals in January 2003 will have enjoyed the recovery that then took place.

“It’s not only the market returns after withdrawals start that matter. Someone retiring in 2003 may have enjoyed a rising market in their early retirement – but their pot is also likely to have been hurt by the crash that happened in the preceding three years,” he said. 

While timing can make huge differences to your portfolio performance, staying invested through thick and thin is still an important way to stop your money from stagnating – in 17 out of the 20 cases illustrated in the chart above, the pension pots were still bigger than they had been when the saver first started withdrawing money. 

How much money should I take out of my pension?

When you are ready to retire, you can start accessing your DC pension through “drawdown”. This is when you start taking regular sums from your pot, while the rest of the money stays invested in the market. Once you enter this stage of retirement, your pension manager will probably start to “de-risk” your investments by allocating more of your money toward assets that are perceived to be less volatile, such as bonds. 

It can be difficult to gauge how much of your pension you should withdraw; while you’ll likely want enough to fund a comfortable lifestyle, overspending means your pot may run out too soon. A general rule of thumb is to start at a 4pc withdrawal level, and then increase this by an average of around 2pc each year to keep up with rising costs – assuming 2pc inflation. At this conservative rate, it is widely believed that you are very unlikely to run out of money over a typical retirement period of 30 years. 

However, it’s worth noting that inflation has not been at 2pc since 2021, so any pensioners following this pattern may find their pension withdrawals have not been about to keep up with rising prices.

What’s more, when markets are falling, taking the same level of income could make a serious dent in your portfolio. Rob Morgan, of the broker Charles Stanley, said: “Selling assets during a market dip leaves less of the pot intact to benefit from a subsequent recovery. It’s essentially the benefit of regular investing, ‘pound cost averaging’, in reverse – so the effect is detrimental rather than positive.” 

How to balance out pension losses

There’s nothing you can do to stop market downturns, or when you find yourself at retirement age, but you can take action to minimise the erosive effect falling investments can have on your pension savings. 

One way is to have a cash savings pot set aside that you can withdraw income from instead, protecting your pension savings when your invested pot is performing badly. This would ideally need to be held in an account that allows you to make withdrawals at fairly short notice, with no restrictions on the number of withdrawals it allows. You’d need to have enough cash to cover your living expenses for long enough to ride out periods of poor investment performance.

Mr Monk said: “For example, you hold two years’ worth of income as cash and pay yourself from that. After a year, if your invested pot of money has fallen in value, you can decide to take the second year of income from the cash pot, rather than selling assets that are now worth less. 

“With luck, in the third year your investments will have recovered some ground and you can replenish your cash pot. There’s no guarantee of it, of course, but by building this flexibility into your plans you may be able to avoid the worst time to sell investments.” 

You may also consider reducing your withdrawals when markets are falling, for example by only taking the natural yield that your portfolio produces from dividends. While this means your income might take a hit, you will not have to sell any of your holdings when their market value is low.