How much cash to hold in retirement

Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

History suggests the gulf between cash and equities grows wider over time - as shown in the graph above. This is important when you’re thinking about your own retirement timeline. On the one hand, you might want to access a chunk of your savings immediately - to pay off your mortgage, for example. In this scenario, cash is the obvious choice.

However, data suggests retirement is a marathon not a sprint.  According to the ONS, a 65-year-old man can now expect to live until he’s 85 and has a one in four chance of reaching his 92nd birthday. Women tend to live even longer: an average 65-year-old will reach 88 and has a one in four chance of hitting 94.¹

People do not always plan for this when building their portfolios. A recent report by Fidelity on longevity found that people often underestimate their life expectancy. Retirement savings are typically planned for 15 to 20 years, but this isn’t necessarily enough.

“Around two in five people aged 50+ are underpreparing for retirement by 10 years or more when measured against the average life expectancy in their location,” Fidelity’s longevity report concludes. “This shortfall leaves many at risk of running out of money later in life.”

That brings us onto the main enemy of cash: inflation. While the face value of your cash savings won’t drop until you start spending, what you can buy with that money could fall substantially due to rising prices.

• Read: How to inflation-proof your retirement savings

This hasn’t been a problem for the past two years, as interest rates have been higher than inflation, meaning the value of cash has increased in real terms. This is not a typical situation, however. Since the base rate was slashed during the financial crisis, the value of cash has more often lost value.

Interest rates and inflation are now almost neck and neck, at 4% and 3.8% respectively.

The bull case for cash

So that’s a whistlestop tour of the problems you may encounter. But cash still plays a vital role in portfolios - particularly in retirement. This is because other assets are volatile.

Take equities. Sometimes they fall and bounce back quickly, as seen this year. When Donald Trump announced sweeping tariffs in April, the S&P 500 fell by over 10%, but it was up again within weeks. This was an unusual situation, but it feeds into a wider trend: the average length of bear markets since 1970 has been just one year and three months, compared with six years and 10 months for bull markets.²

Sometimes, however, recovery is far slower. It took the US equity market four years to return to growth after the global financial crisis and over seven years to recover from the dotcom bust.³

This doesn’t matter if you can leave your investments untouched for long swathes of time. In retirement, however, you may need to sell assets to fund your lifestyle, meaning you risk crystallising your losses. This is a hard pill to swallow at the best of times, but it’s particularly damaging if it happens early in your retirement.  This is due to something known as ‘sequencing risk’.

Imagine two people retire with the same amount of money and get the same average return over 30 years. However, one of them experiences a market crash early on, while the other gets good returns early on.

Even though the average return is the same, the person who had a rocky start risks running out of money much sooner, assuming they withdraw money regularly for retirement income. This is because they are forced to sell investments when they are down, meaning they are left with fewer units to benefit from the recovery.

There are a few ways to avoid this. Some retirees choose to live off ‘natural income’ - the interest and dividends yielded by their investments. This mitigates sequencing risk as the underlying assets stay invested. The obvious disadvantage, though, is that income is likely to vary year to year. 

As such, many people like to have a cash buffer, particularly now interest rates are elevated. “With all the rumours of a bubble forming, particularly over in the US, people are seeing cash more as an alternative asset class,” says Sophie Martin, a wealth relationship manager at Fidelity.

“Whereas before, people might have had mostly equities and bonds, they're now incorporating cash as well.”

Even this has complications, however. After all, the cash bucket must be refilled each year. If assets need to be sold to achieve this, sequencing risk rears its head again.

One approach people take is the ‘equity glide path’. This strategy was developed about a decade ago and involves starting with a low exposure to equities - usually between 20-40 per cent - rising over time to between 40-80 per cent.

This might sound counterintuitive, but the benefit is that the equity proportion of a drawdown fund is lower in the early years when sequencing risk can be most damaging. In contrast, market volatility has less impact later in retirement when stock market exposure is much higher.

Other safety nets

So far, we have been ignoring an elephant in the room: annuities.

Since George Osborne introduced ‘pension freedoms’ 10 years ago, retirees have had two basic options. They can draw income from their pension while keeping the rest invested, or they can buy an annuity, securing a fixed income for life in exchange for their retirement savings.

Annuities were out of favour for many years because rates were so poor. However, higher bond yields have made them far more lucrative, and annuity sales soared to their highest level in a decade last year.

“If you’re fortunate enough to have an annuity or a defined benefit pension scheme - or both - you’ll probably feel as secure as you’ll ever feel,” says Fidelity’s Charlie Nicol. “You have no risk of redundancy.”

As such, the need for a cash cushion is less urgent.

“Typically, a defined benefit scheme or an annuity covers the day-to-day outgoings,” says Sophie Martin. “But you might still need cash for those larger one-off expenses and it's always prudent to keep an emergency fund, for if the boiler packs in or you need to replace the car.”

If you’re reluctant to go all in on a lifetime annuity, there are other products that could reduce the need for a big cash buffer.  For example, you could buy a fixed term annuity. These provide guaranteed income for a set period of time - typically five to 10 years - and promises a ‘maturity amount’ at the end of the term.

Personal circumstances

That’s the theory. When it comes to financial planning, however, everyone is different - and cash is particularly divisive.

When you’re weighing up the pro and cons, be sure to consider what financial advisers call your ‘capacity for loss’. How far can your investments fall before your lifestyle, goals and financial security start to be affected? Could you still pay the bills if the S&P 500 dropped by 20%? Could you still go on holiday you had planned?

Risk appetite is crucial too. Objectively, you might be able to withstand some big losses, but if you are losing sleep over a market crash, something needs to change.

As with so many things in the thicket of retirement planning, deciding how much cash you need is an art, not a science.

The government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Our retirement specialists can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

This article was originally published in Investors Chronicle

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• Read: How to make cash-like returns - without a cash ISA
• Read: The silent retirement risk we all ignore - and how to manage it
• Read: How to create a retirement salary

Source:

¹ ONS life expectancy calculator
² Vanguard, 31 December 2024
³ UBS Global Investment Returns Yearbook 2025