How To Plan For A Risk-Free Retirement

The industry's solution to your last ten or fifteen years of retirement planning is contradictory. Read how a Fool might do it.

There is a clock that allows you to type in your age, whether you smoke and so on, and then it `calculates' when you're going to die. The clock sits on your computer desktop, ticking down to your death. That tickles my macabre sense-of-humour.

Those of you with less than fifteen years until retirement could perhaps do with a similar clock which counts towards that somewhat happier occasion. Not only do you see your future freedom ticking ever closer, but it gives you a focus for your financial goals. 

So, what should you do with your retirement pot during this fifteen-year countdown?

If you have a secure final-salary scheme that will support you sufficiently, then you might not have any serious planning to do at all. Most of us, however, are investing our money in such things as the stock market or property. These markets have two main defining characteristics:

1. Over the long-term, they go up (so far, anyway).

2. In the short-term they can fluctuate dramatically, rocketing upwards or plummeting downwards.

Over the decades you have been investing (I hope) for your retirement, your retirement pot will have gone up and down and sideways. By now, however, most of you should have a considerably bigger pot than the total amount of money you put into it.

You will shortly be offered products by the pension industry which include something called a `lifestyling option'. Indeed, if you're using pension to save for retirement then you may already have selected this option years ago and forgotten all about it.

The financial industry's solution

Lifestyling is the industry's answer to the question `What should you do with your retirement pot during the fifteen years before retirement?' Each provider has its own scheme, but they're basically variations on a theme. Here's an example of how one might work:

Stage One

14 years until you expect to retire. The provider moves say 20% of your riskier investments, e.g. shares in emerging markets, to shares in big UK companies, which are expected (although not guaranteed) to be more stable.

13 years to ten years remaining. A similar size of your pot is moved to these safer shares every year for four more years until it's all invested in UK companies.

Stage Two

Five years remaining. 20% of your fund is moved from UK shares to bonds or cash accounts, where it will earn interest, and where it cannot be hit by a fall in the stock market.

Four years to one year remaining. A similar size of your pot is moved from UK shares to savings each year, which gradually makes your retirement pot safer.

Does it work?

Lifestyling is not the scariest idea to originate from financial companies. I'm sure that most people who've saved diligently come out the other end of it in a financially sound position. However, my opinion is that lifestyling doesn't suit those who already have a big enough pension pot for their needs.

Once you accept that investing is for the long-term (the industry and The Fool agree on that much), and providing your pot is big enough, then it makes no sense to have any money invested in the stock market in the last five or, more preferably, ten years before you start drawing an income from it. (An exception is where you've decided to continue investing the money beyond retirement, but this article is aimed at the majority who don't.)

Imagine: there are only five years to your retirement and you have a nice healthy pot. Then a war starts. Or credit crunches once again. Or the economy collapses. The stock market crashes heavily in just two months and continues to fall for three years before recovering somewhat over the next two. If you use lifestyling, you might lose 20% or more of your pension pot over those five years. This means that you're post-retirement income will be four-fifths of what you thought it would be. A £20,000 annual retirement income becomes £16,000. Ouch!

Hopefully the more aware financial companies will contact you before too much damage is done and recommend that you move your funds out, but my view is that, for many people, the money should not have been at risk during those final years at all.

A more Foolish way to approach retirement

The industry always tells younger investors to invest for the long-term, but older ones are told to continue investing for the short term, albeit in smaller amounts. That is contradictory.

The alternative is to get out of shares altogether at least five years before you retire. Assuming you're lucky enough to have saved the pot you need (factoring in the impact of inflation) five or even ten years before your expected retirement date, then as soon as you hit your target, I think you should transfer all your investments to cash funds, where it will earn interest until you retire. Why take the risk that the stock market will fall when you've got all you need?

One thing's for sure, I do not want to be invested in the stock market at all when I have less than five years to do so.

How to get started

To plan the 15 years or less that you have remaining, you'll first have to estimate the pot you'll need when you retire. You can calculate this using my Four-Step Guide To A Comfortable Retirement. Then you are ready to track your pension and get out of riskier investments when the time comes.

If you have five years remaining, but find that you're far short of your target, that is a totally different kettle of fish. The big question to ask yourself is: should I gamble my pension on the stock market over a short period of time, or should I cut my losses and move it to cash funds? The choice for me would be easy; I'd cut my losses so that I knew I at least had some money of my own, and focus on reducing my bills and earning more money over the next five years. However, it depends on your attitude and personal circumstances.

Really, though, funding your retirement if you haven't saved enough is not the topic of this article. You can get more guidance in this podcast or by searching our retirement article archives.

What you invest in is also very important, because not all investments are equal! You can read about The Fool's top tip here and more on it here.

> You can save for retirement using shares ISAs and get out of shares within the last five to fifteen years by transferring your share ISA investments to cash ISAs.