The cash buffer for your pension – and why it’s so important
Before we introduce the portfolios in which the great majority of your pension pot will be invested, we need to mention a vitally important subject: the need to keep a substantial sum in cash.
There are a couple of reasons to have a cash buffer. The first is that if the economy or stock market takes a severe beating and the income paid by your funds falls, you can use the cash buffer to maintain your desired level of income
In the absence of a cash buffer, a downturn in the markets could force you to maintain your income by selling some of your investments at low prices, which in turn would erode their income-generating ability in future, setting in train a potentially deadly vicious circle. We cover this subject in more detail in Step 4 under the heading “The biggest danger to your pension savings – and how to neutralise it”.
Another reason for a cash buffer is to guard against any technical or administrative problems at your platform or funds that could mean a delay to the payment of your normal income.
Our rule for the cash buffer is this: You should set aside enough money to meet your normal income needs for one year and hold it in an easy-access savings account with a bank or building society.
Calculate your income needs in retirement
In order to prepare your finances for retirement effectively, you need to know how much income you’ll require after retirement.
List all items of expenditure, including all daily, weekly, monthly and annual payments. Be sure to cover the less obvious ones, such as subscriptions, membership fees, the TV licence, and even travel spending and gifts.
Then add 10% for unexpected spending.
If you are some way from retirement, be sure to account for inflation (assume an inflation rate of 2.5% and use an online calculator such as the one at www.calculator.net/inflation-calculator.html).
There you have it – you now know the amount of cash to keep in your cash buffer.
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