9th March 2013
The Bank of England Monetary Policy Committee has voted against further quantitative easing (QE) for the time being, but many economic experts believe this is simply delaying the inevitable.
Jill Insley considers the problem this is causing for those approaching retirement and some things they can do about it.
Howard Archer, chief UK economist for analysts IHS Global Insight says the decision was “highly likely the result of a tightly split vote”, and that the MPC will vote for more QE in the second quarter of 2013, possibly as soon as April.
“We expect the Bank of England to deliver one £25bn portion of QE in the second quarter (taking the stock up to £400bn) with another £25bn portion (taking the stock up to £425bn) occurring shortly after Mark Carney takes over as Bank of England Governor in July,” he said.
For people in the run up to, and on the point of, retirement, this could be disastrous. QE involves the Bank of England pumping money into the economy by buying up assets – typically gilts – from banks and other financial institutions. This pushes up the value of those assets, and in the case of gilts, reduces their yield.
Annuities, which are still the most popular option for those wanting to convert their pension fund into an income stream, are based on gilt yields. So by reducing the yield on a gilt, QE is also reducing the amount of pension income someone can buy with their pension fund.
Ros Altmann, director general of Saga and former pensions adviser to Downing Street, has described the QE programme as “a monumental mistake”, with monetary easing had acted like a “tax increase” on older people.
QE has not been the only influence on pensioners’ income over the past couple of years: new solvency regulations for insurers which force them to buy bonds, investors’ flight to safety caused by uncertainty about the future of Europe and a European directive forbidding insurers from using gender to calculate annuity rates have also taken their toll.
But whatever the reason, annuity rates have plummeted since the first tranche of QE, from 7.21 per cent for a level income for a 65 year old man in March 2009 to 5.79 per cent now. This means a man buying an annuity now would get just £5,791 a year, almost a third of the £15,600 a year he would have secured when annuity rates peaked in 1990.
So what can those who are preparing for and about to take retirement do to make up the difference?
Run up to retirement
Traditionally people in the run up to retirement switch their money from equities into lower risk assets, including bonds. Laith Khalaf, pensions expert with independent financial adviser Hargreaves Lansdown, points out that the same price hikes which have depressed annuity rates have boosted the value of bonds held by pension funds.
This is great for those who have had their money invested in bonds for the last few years, but many investment experts now fear that bonds are due for a price correction.
While this means that annuity rates should improve, Khalaf suggests that those with just a few years to go until retirement should consider switching their money from bonds into cash, or absolute return funds for those prepared to take a bit more risk and with more than five years to go.
Next check whether your pension entitles you to a guaranteed annuity rate (GAR). These tend to be attached to pensions started in the late 80s and early 90s, and provides the beneficiary with a much higher rate than those available now. However some GARs come with restrictions: you may not benefit from the higher rate if you opt for a joint life annuity (which pays an income to your partner after your death) or an inflation linked income.
If possible top up your retirement savings. At this late stage the most cost effective way to do this is through a pension scheme: if you belong to a company scheme, your employer will also make contributions on your behalf, and if you are a higher rate tax payer you will benefit from an immediate 40 per cent uplift in the amount you invest. Your eventual pension will be taxed, but provided your tax rate drops to the basic rate when you draw your income, your money will still have appreciated by 20 per cent.
Shop around for an annuity
Possibly the most important action you can take to improve your pension income is to shop around for an annuity – a process called exercising your open market option. Most people simply opt for the contract offered to them by their pension provider, but this rarely produces the highest income.
Since the EU banned the use of gender for underwriting annuities last December, insurers have paid far more attention to other details, including where the annuitant lives, their lifestyle, what their occupation has been and especially their health. If you suffer from a medical condition or indulge in habits that could limit your life, you could be entitled to an “enhanced” annuity and benefit from a much bigger income – up to 40 per cent in some cases.
You may also want to consider using income drawdown to generate an income from part or all of your pension fund. With income drawdown, your money is left invested, and you take out an income subject to limits set by HM Revenue & Customs.
At the moment, investors are limited to withdrawing an income equivalent to the amount they would get from a single life annuity bought with the same amount of money. But this is set to rise to 120 per cent of that amount from 26 March.
This can be a risky way to generate a pension income and it’s vital to take professional advice from an independent financial adviser. While the money produced by an annuity is guaranteed to continue until you die, there are no such guarantees attached to income drawdown. If you withdraw too much money, or the underlying funds perform badly, you could find that you run out of money altogether.
However Khalaf says: “This is a more flexible way to generate a pension income – there are death benefits, you can move from one pension manager to another and can alter the amount of income you draw.”
Income drawdown is not generally recommended for investors with less than about £150,000 in their pension fund. But Khalaf says that sources of retirement income should be considered in a holistic way: “If someone has a pension coming from an occupational scheme, and income from investment property, then if they have £40,000 in a personal pension it’s not unreasonable to use this for income drawdown.”