How to protect your pension income

Let's travel back in time say, ten years. You're a pensioner. You're on your summer holidays, perhaps in a caravan park on a particularly gorgeous part of the coastline in the west of Scotland. You pick up a newspaper. You see that global stockmarkets are in total disarray. Even the FTSE 100 is down 10%. What do you do?

The answer, I suspect, is nothing much. You either have a defined-benefit pension (you are getting paid a percentage of your final salary, inflation-linked, forever), or you have handed over all your savings in return for an annuity that will pay you an income for life. You might have some bits and bobs in the market, but overall where share prices go or don't go is entirely by the bye to your enjoyment of your holiday. Which is nice.

Now let's travel forward in time again by, say, ten years. The same thing happens. What do you do? My guess is that you feel a little panicky and a little sick. Why? Because you are in drawdown. All your savings are still in the stockmarket one way or another, and you are depending on them to provide you with the income and capital you need for another 25 years of caravanning. The capital you have in the market is "irreplaceable capital" (you aren't earning any more of it). Losing 10% of it in a week isn't part of the plan.

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The last few weeks have offered new pensioners a pretty nasty lesson in the downside of George Osborne's new pensions freedoms: anyone who hangs on to their own money runs the risk of losing it. And, as Ian Cowie points out in The Sunday Times, "retirement is a bad time to discover the dangers of stockmarkets" and the fact that, in the new world of pensions, it is perfectly possible for "your savings to expire before you do". So what can you do to mitigate your risks?

The obvious answers to this question are the usual ones. Take advice. Diversify. Look for good-quality stocks paying reasonable incomes or look for fund managers who are finding them. Remember, you have made a long-term commitment to the markets. Be careful not to take a higher income than your fund can stand.

But the huge moves in the market make it clear that you should do one more thing: keep cash. The real danger to a long-term portfolio is not the market falls themselves, but having to sell in to those market falls. You need, Darius McDermott of Chelsea Financial Services tells Cowie, to have a "cash buffer equal to at least one year's expenditure, preferably two" to make sure that you can "ride out" tricky market periods without having to sell into fast-falling prices.

We completely agree.