Households already have enough to worry about. The cap on energy bills has risen again, the price of goods is soaring and mortgage rates are hitting levels not seen for over a decade. Then, last week, fears about pensions were added into the mix.
The Bank of England said on Wednesday it would step in to buy £65billion of Government debt to protect pension funds, warning that otherwise there was a material risk to UK financial stability.
So what does last week’s turbulence mean for pensions? Are we back to normal, now that a crisis has been averted, or might we still have to rethink when or even if we retire, and how much we can expect to spend in later years?
Nest egg: Are we back to normal, now that a crisis has been averted, or might we still have to rethink when or even if we retire
Added protection for gold-plated pensions
The pensions that the Bank of England stepped in to rescue last week were private sector defined benefit – also called final salary – schemes. These are the most generous, as they pay out a guaranteed income for life based on your earnings, and have some protection against inflation.
About ten million people in the UK are part of this type of scheme. Though they have largely been phased out to new members in the private sector, about a million non-state sector workers still pay into one.
These pension schemes came unstuck last week when the Government’s cost of borrowing rose sharply. They use complex financial instruments designed to reduce risk, but which are strongly tied to the cost of Government debt. When debt yields rose, pension schemes had to quickly start selling assets at bargain-basement prices to balance the books.
While this was a very precarious situation, the important thing is the Bank of England stepped in to calm markets down, and was successful. This should offer members of these schemes some reassurance should things go awry again.
Furthermore, though these schemes were momentarily in jeopardy, they are fundamentally in good nick. They have more than enough in the pot on average to cover liabilities.
The ultimate responsibility for final salary schemes lies with the companies that offer them. If a scheme did not have enough to pay out its promises to members, the firm would be obliged to step in. And if it becomes insolvent its final salary scheme is taken over by the Pensions Protection Fund, so members still receive a pension.
In short, people who have their nest eggs in final salary schemes are very well protected.
What of other workers saving for retirement?
Most workers save into a defined contribution pension scheme. If you are saving through auto-enrolment, you will have this type of pension.
Both the employer and employee chip into these each month – and contributions are topped up by the Government in the form of tax relief.
The money is invested in financial markets to boost its worth. The value of this type of pension is determined by how much is put in and how well its investments perform.
Most savers with these pensions will have seen the value of their nest egg fall over the past year in general, and the past week in particular. This is because markets have had a terrible week. The value of firms listed on the London Stock Exchange has fallen by around 2.5 per cent this week, while an index of the biggest companies in the world is down close to 1 per cent – and 25 per cent this year. While it can be tempting to stop saving when markets are falling and household bills rising, ceasing contributions can lead to future disaster.
Becky O’Connor, head of pensions and savings at investment platform Interactive Investor, says that market ups and downs are part and parcel of long-term investing.
‘Don’t be dissuaded from continuing with a pension, especially if you are a way off retirement,’ she says. ‘Your pension pot is for your retirement, and is your best chance of having one, regardless of what is happening to markets right now.’
Market falls can even be good news for younger savers a long way off retirement. This is because the investments they buy for their pensions are now much cheaper. Plus, they have time to ride out the turbulence and hopefully benefit from growth over the long term.
Why it helps to drip feed your savings
If you are still paying in to a pension, saving a little regularly is likely to be a better option than investing in chunks. By saving monthly you are saving through good times and bad in the hope that the price you pay for investments averages out over time.
Investing a lump sum can be hugely profitable if you are lucky enough to invest at the right time. But time it wrong – and no one can really successfully time the market – and you could be putting all of your money into the markets just at the wrong time before a crash.
What about those who have already retired?
Retirees are likely to have seen a hit to their nest eggs over recent weeks. For most, it would be prudent to stay invested so savings have time to recover. Taking money out of a pension now will lock in any losses and makes it that much harder for saving to bounce back when financial markets improve.
However, for millions of retirees this is easier said than done. Rising numbers are in fact withdrawing more from their pensions to tackle the rising cost of living.
Between April and June this year, more than half a million people withdrew £3.6billion from their retirement pots – a 23 per cent increase on the previous year. Tom Selby, head of retirement policy at investment platform AJ Bell, says: ‘With millions of families struggling to pay the bills at the moment, for many turning to their hard-earned pensions will feel like the only option. There will also inevitably be lots of parents or grandparents who are taking some income from their pensions to help younger generations get by.’
Many retirees will have no choice but to draw on savings to make ends meet. But anyone who possibly can, should consider reducing withdrawals in the short term to preserve the value of their pot. Some retirees may have to consider deferring retirement due to the recent market falls, or even returning to work if they have recently left the jobs market.
Gary Smith, financial planning director at wealth manager Evelyn Partners, suggests that over-55s who are planning to take a 25 per cent tax-free lump sum from their pension should consider delaying this or taking part of it and leaving the rest invested.
‘Withdrawing the tax-free lump sum takes a big chunk out of one’s pension savings at the start of retirement, or even before, and the diminished pot is then likely to provide a leaner income over the remaining retired life,’ he says.
‘Many pension funds have done poorly this year, so taking a lump sum now will probably mean crystallising losses rather than letting investments recover. This could inflict a double whammy on one’s personal wealth.’
But there is some good news…
Savers who are looking for a guaranteed income for life will find they can get a considerably better deal following the recent market turbulence. Annuity rates have risen by nearly 40 per cent this year so far, thanks to rising interest rates and Government bond yields.
A 65-year-old retiree with a £100,000 lump sum, can buy themselves an annuity with an income of about £6,600 a year for life. At the start of the year, they wouldn’t have got more than around £4,800.
Annuities fell out of favour in recent years because the incomes they offered were so stingy that savers felt they could produce a better income by keeping their savings invested and drawing on them as they needed.
However, with annuity rates going up and with the security they provide, annuities are starting to look much more favourable.
And, offering further reassurance for pensioners, Chancellor Kwasi Kwarteng on Thursday committed to maintaining the state pension triple lock.
This guarantees that the state pension will rise by either inflation, wage growth or 2.5 per cent – whichever of the three is highest.
With inflation at about 10 per cent, the full annual state pension is likely to breach £10,000 for the first time in April next year.
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