Pensions and interest rates: the good, the bad and the ugly news!
The old saying goes, ‘I have good news and bad news, which would you like to hear first?’. Given this choice, a majority prefer to hear the bad news first. The recent reduction in UK interest rates to 0.25% in response to pressures on the post-Brexit economic situation is both good news and bad news; for some however it’s ugly! It all depends on perspective and how the reduction affects everyone individually.
The bad news
The bad news is that bank deposit rates will be reduced once again. Those relying on income from deposits will see further reductions in their monthly ‘salary’. If retired, there’s not a lot that can be done about it without changing course and taking a little more risk. There is more bad news for anyone planning to retire on an annuity. With rates at historic lows and destined to fall further as long-term bond yields follow suit, annuity incomes are likely to be lower with no change predicted in the near future. On top of this, Sterling has devalued by around 15% since Brexit. As such, anyone working or retired in the Eurozone and depending on a Sterling income from other sources (Buy to Let for example), will see that income fall and the value of any assets automatically reduce.
The ugly news
The ugly news is unfortunately ‘in the post’ for those who live/work in the Eurozone with savings and income in Sterling bank deposits and/or annuities. Even worse news may be on the way for those depending on a Defined Benefit (DB) pension, if income calculations are changed at some point in the future. With so many DB schemes in serious deficits, something will inevitably have to give. The UK Pension Protection Fund can help to a limited extent, though it only covers members whose employer went bust and is limited to a maximum of 90% of the top annual pension rate of £37,420 at age 65. Earlier retirees would receive a reduced top rate.
DB scheme actuaries are in a difficult position. On the one hand they are bound by scheme rules to pay benefits at pre-agreed levels. On the other, many employers have adopted a policy of reducing contributions. As a result, the total pot is falling at a faster rate than can be sustained in order to pay future liabilities. Additionally, the low interest rate environment means that even more money must be reserved to pay retirees due to the need to guarantee retirement income. Again, something has to give. We are already seeing reductions in the indexation of benefits for those in retirement and the freezing of salaries for those still working. The move from final salary benefits calculations to average salary is yesterday’s news; we now witness DB schemes being closed to new members on a daily basis.
The good news
So what’s the good news? For a start, those with borrowings in Sterling can look forward to lower monthly payments on their mortgages and loans. ‘Buy to Let’ expat landlords may find this useful as the drop in Sterling is compensated by lower interest rates. Companies will also benefit from this lower rate environment, which should help sustain profits; many will see slight increases simply due to lower borrowing costs. Higher profits for companies should mean they are able to maintain or even increase dividend payments. Those investing for income via Defined Contribution (DC) schemes should see fund values and dividends rise.
There is other good news for EU retirees. Some DB scheme trustees are offering greatly enhanced Cash Equivalent Transfer Values for those who wish to transfer to a DC scheme such as a QROPS or offshore SIPP. With long term interest rates so low and average mortality rates rising, more money must be reserved to pay for your pension. Anyone considering this option needs to examine all the implications carefully. However, there appears to be a tipping point at which it becomes so attractive to transfer that it makes sense to do so. QROPS and SIPPs offer flexible benefits, with no need to take an annuity on retirement. Full investment flexibility allows currency risk to be completely eliminated; a wide range of acceptable assets can also be held such as gold, high yield bonds and equities from every sector of the market. In addition, investors have access to high quality income funds with yields in excess of 3%.
As always in financial planning, we need to adapt our retirement strategies as the situation changes. When in doubt, seek professional advice!