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Households already have enough to worry about. The cap on energy bills has risen again, the price of goods is rising and mortgage rates are reaching levels not seen in more than a decade. Then, last week, there was the fear of pensions.
The Bank of England said on Wednesday it would step in to buy £65bn of government debt to protect pension funds, warning there would otherwise be material risk to the UK’s financial stability.
What does last week’s turbulence mean for pensions? Now that a crisis has averted, are we back to normal, or do we perhaps need to reconsider when or even if we’re going to retire, and how much we can expect to spend in later years?
Nestei: Are we back to normal now that a crisis has averted, or maybe we should reconsider when or even if we retire
Extra protection for gold-plated pensions
The pensions that the Bank of England came to the rescue last week were private sector defined benefit plans, known as final pay plans. These are the most generous, as they pay out a guaranteed lifetime income based on your earnings, and offer some protection against inflation.
About ten million people in the UK are part of these types of schemes. Although they have largely been phased out to new members in the private sector, about a million non-government workers still pay in one.
These pension plans were jeopardized last week as the cost of government borrowing soared. They use complex financial instruments designed to reduce risk, but which are strongly linked to the cost of government debt. As debt yields rose, retirement plans had to quickly sell assets at spot prices to balance the books.
Although this was a very precarious situation, the most important thing is that the Bank of England intervened to calm the markets and was successful. This should provide members of these schemes with some reassurance should things go wrong again.
In addition, while these arrangements were temporarily in jeopardy, they are fundamentally in order. On average, they have more than enough in the pot to cover the obligations.
The ultimate responsibility for final pay plans lies with the companies that offer them. If a scheme didn’t have enough to pay off its promises to participants, the company would have to step in. And if it goes bankrupt, the final salary scheme is taken over by the Pension Protection Fund, so that the participants still receive a pension.
In short, people who have their nest in final pay schemes are very well protected.
What about other employees saving for retirement?
Most employees save in a defined contribution pension plan. If you save via automatic registration, you have such a pension.
Both the employer and the employee pay into this monthly – and the premiums are supplemented by the government in the form of tax relief.
The money is invested in financial markets to increase its value. The value of this type of pension is determined by how much is invested and how well the investments are performing.
Most savers with these pensions will have seen the value of their nest fall over the past year in general and the past week in particular. This is because the markets have had a terrible week. The value of companies listed on the London Stock Exchange has fallen about 2.5 percent this week, while an index of the world’s largest companies is down nearly 1 percent – and 25 percent this year. While it may be tempting to stop saving when markets fall and household bills rise, stopping contributions could lead to future disasters.
Becky O’Connor, head of pensions and savings at investment platform Interactive Investor, says market ups and downs are an essential part of long-term investing.
“Don’t let that stop you from retiring, especially if you’re a long way from retirement,” she says. “Your pension pot is for your retirement, and it’s your best chance of having one, no matter what happens to the markets right now.”
Market declines could even be good news for younger savers who are a long way from retirement. That’s because the investments they buy for retirement are now much cheaper. Plus, they have time to get out of the turbulence and hopefully benefit from the long-term growth.
Why it helps to drip your savings
If you are still paying for retirement, saving a little regularly is probably a better option than investing in chunks. Saving monthly allows you to save 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 time the market successfully – and you could be putting all your money into the markets just at the wrong time for a crash.
What about those who are already retired?
Retirees have likely seen a hit in their nest eggs in recent weeks. For most, it would be wise to stay invested so that savings have time to recover. Taking money out of retirement now will hold any losses and make it much harder to save when the financial markets improve.
For millions of retirees, however, this is easier said than done. In fact, rising numbers are taking more of their retirement benefits to deal with the rising cost of living.
Between April and June this year, more than half a million people took out £3.6bn from their pension pot – a 23 percent increase on the previous year. Tom Selby, head of pension policy at investment platform AJ Bell, says: “With millions of families struggling to pay the bills right now, many going into their hard-earned retirement will feel like their only option. Inevitably there will also be many parents or grandparents who take part of their pension to help the younger generations get by.’
Many retirees will have no choice but to raise savings to make ends meet. But anyone who can should consider cutting short-term withdrawals to preserve the value of their pot. Some retirees may need to consider postponing retirement due to recent market declines, or even going back to work if they’ve recently left the job market.
Gary Smith, director of financial planning at asset manager Evelyn Partners, suggests that people over 55 who plan to take a tax-free amount of 25 percent of their pensions should consider deferring or taking part of it. and leave the rest invested.
“Withdrawing the tax-free lump sum will take up a large portion of retirement savings at the start of retirement, or even before that, and the reduced pot will then likely yield a meager income over the remaining retiree life,” he says.
“Many pension funds have done poorly this year, so taking a lump sum now probably means crystallizing losses rather than allowing investments to recover. This could be a double whammy to one’s personal wealth.’
But there is good news…
Savers looking for a guaranteed income for life will find they can get a significantly better deal after the recent market turbulence. Annuity rates have risen nearly 40 percent so far this year, thanks to rising interest rates and government bond yields.
A 65-year-old retiree with a lump sum of £100,000 can buy himself an annuity with an income of around £6,600 a year for life. At the start of the year they would have gotten no more than about £4,800.
Annuities have fallen out of favor in recent years because the incomes they offered were so stingy that savers felt they could make a better income by keeping their savings invested and using them as needed.
However, with the annuity rates rising and with the security they provide, annuities are starting to look a lot more favorable.
And to further reassure retirees, Chancellor Kwasi Kwarteng committed to maintaining the triple state pension scheme on Thursday.
This guarantees that the state pension will increase with inflation, wage increases or 2.5 percent – whichever is higher of the three.
With inflation around 10 per cent, the full annual state pension is likely to exceed £10,000 for the first time in April next year.
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