Bad news for pensions
Over the last couple of weeks Brett has been discussing the Bank of England's attempts to restart the economy through quantitative easing (QE), the principles behind it and the possible pitfalls if it is not monitored appropriately.
However, the Bank's decision will have wider consequences, namely – more bad news for pensions.
The effect of QE will impact on pension investments in several ways with both defined benefit (DB) and defined contribution (DC) schemes coming off worse as a result of the government's actions.
Whilst DC pensions have small liquidity needs (as the income from contributions and investment are sufficient to cover benefit payments and other expenditures), DB plans rely on their assets to supply pension incomes to retired members. Although QE could potentially see the value of these assets rise, the immediate response to QE will be seen in the value of its liabilities.
The price of DB pension liabilities are based on the yields of long-term gilts, however with the main objective of QE to increase the value of assets and decrease yields, the lower interest rate produces a higher level of liabilities and could plunge many schemes into serious difficulty.
Already the yields on longer-term 10-year gilts have fallen by around 21-30 basis points and it is estimated that in within the first week of QE the pension deficits facing some of Britain's largest DB schemes jumped by around £100 billion to a record £390 billion, an equivalent of over £150,000 for every member of a DB pension.
The decline in yields are also going to negatively influence annuity rates which means that not even DC pensions escape the backlash of QE.
Similar to calculating pension liabilities, gilt yields are used to work out annuity rates. Subsequently, major annuity providers, such as Legal & General and Norwich Union have already lowered their rates by up to 2%. This has prompted pension advisor's to suggest to anyone thinking of buying an annuity within the next six months to do so sooner rather than later. When doing so it might be prudent to invest at least part in an inflation-linked annuity to protect your investment in case the government gets it wrong and inflation rockets.
Alternatively, if you can delay buying an annuity for a few years, rates could recover and you will receive an improved income from your annuity, although neither action is guaranteed to be the best option.
Even though the returns of DB schemes should technically be covered by the employer, the implications of QE could push those schemes already in deficit into insolvency. For those schemes enrolled in the Pension Protection Fund, established by the government to provide compensation to members of eligible DB pension schemes, members will receive a proportion of their pension with a maximum yearly income of £27,771. Read our earlier investment news article to learn more about the PPF.
No industry has avoided the current economic downturn but considering pensions are supposed to provide peace-of-mind that your retirement comfort is guaranteed they are clearly failing spectacularly.
These are meant to be the experts and whilst the government's actions have not helped, there is obviously something drastically wrong with the system that can give such variable returns on your investments for your future.
If you're unsure that what's still left in your pension pot will fund your retirement, then give the team a call on 0207 812 1255 and we'll show you how our four industry unique guarantees will make property investment an easy choice for you and your family.