Savers and pensioners face pain as inflation rises and annuity rates drop
THE Bank of England’s decision to embark on another round of quantitative easing (QE) delivered a cruel blow to savers and pensioners already reeling from the effects of rising inflation and low interest rates.
The Bank is pumping an extra £75 billion of cash into the UK economy in an attempt to stave off a deep recession as fears grow over the health of the UK, European and global economies. That extra money is being used to buy gilts, driving up their price and so pushing down the yields from them. QE is also set to result in higher inflation: as the supply of cash increases, the price reduces and the pounds weakens.
In some way or another it is likely to have some impact on your finances, with particular ramifications for pensioners, savers and even borrowers. Here’s a look at some of the probable implications for your money:
PENSION INCOMES TO FALL FURTHER
A new round of QE is bad news if you’re nearing retirement and intending to buy an annuity, or if you’re already retired and in an income drawdown contract.
Annuity prices are dictated largely by gilt yields and as they fall providers are likely to cut annuity rates again. The income available from annuities – with which the vast majority of retirees convert their pension fund into a retirement income – has already slipped to new lows over recent months. Figures from Hargreaves Lansdown show that the benchmark level annuity rate for a 65-year-old male had already slumped below the £6,000 mark by the end of last month.
Gemma Goodman, of Alexander Forbes Annuity Bureau, said: “October again saw some large falls in annuity rates, which, following cuts in September, is worrying news for those approaching retirement, especially given the Bank of England’s decision to increase its QE programme, which reduces the interest rates on gilts and corporate bonds and drive down annuity rates further.”
The previous QE announcement in 2009 was quickly followed by 18 annuity rate cuts as providers responded to lower gilt yields.
Billy Mackay, marketing director at pension firm A J Bell, said: “The need to stimulate the economy is only too clear but an unfortunate side-effect of quantitative easing is it will result in another cut in pensioners’ income at a time when they can ill afford it.
“This comes as a real blow because gilt yields were already at record lows before this £75bn stimulus package was announced. It’s entirely feasible that this will lead to further falls and heartache for people reviewing their pension drawdown or considering buying an annuity.”
Tom McPhail, head of pensions research at Hargreaves Lansdown, urged retirees to shop around for the best annuity they can get, but added: “Don’t delay buying an annuity in the hope of a short-term bounce in rates – it may happen but there is no strong reason to expect it.
“If you want to minimise the risk of buying an annuity at the wrong moment or you hope that asset prices may recover, then consider phasing your annuity purchase.”
Make sure you shop around for your annuity, rather than immediately accepting your pension company’s offer – with a 20 per cent gap between the best and worst rates on offer, it could make a huge difference. And if you’re a smoker or in poor health you can apply for an enhanced annuity.
Lower annuity rates also spell problems for pensioners in drawdown schemes, where funds are left invested at retirement and taken when required.
The amount that can be taken each year has already been slashed in recent months, following a government rule change that lowered the maximum that can be taken from 120 per cent of the rate on comparable annuity to 100 per cent. And as annuity rates drop, that maximum will too.
Mackay said: “Everybody appreciates the need for action on the fiscal challenges the government faces. However, you can’t ignore the impact of unintended consequences and action is needed to address this issue. We have been calling for changes to the drawdown income rules, this only adds fuel to that argument.”
Elsewhere, QE also poses a threat to final salary pensions. Company pension deficits are set to increase as a result of fresh QE, because lower gilt yields will make it more expensive to pay the final salary pensions of those in retirement. The number of final salary schemes open to new and existing employees has plunged dramatically in recent years and the National Association of Pension Fund has warned that QE puts “additional pressure on employers at a time when they are facing a bleak economic situation”.
Many of the firms affected will seek to reduce their pension costs, which could include closing schemes or offering members (often dubious) incentives to transfer out.
SQUEEZE TIGHTENS ON CASH SAVERS…
Inflation has proved a formidable opponent for savers over the last three years and there are now no conventional savings accounts available that protect savings from being eroded by rising prices. The battle to get returns that keep pace with inflation just became harder, however, with QE set to drive prices up even higher. Some experts believe inflation could now reach 6 per cent, given the previous round of QE added some 2 per cent to inflation.
Savers were dealt a severe blow last month by the withdrawal of the NS&I index-linked certificates and while the Post Office relaunched its inflation-linked bond last week, options for those seeking real returns from their cash are very limited.
The average easy access account now pays just 0.94 per cent, according to Moneyfacts, and while rates on Isas and fixed-rate bonds are far more competitive – with a number of cash Isas paying more than 3 per cent – they still fall short of inflation. For the best cash deals you have to leave your cash untouched for three years or more, a restriction that deters older savers in particular.
As inflation creeps up even further, the challenge of finding real returns from cash will now become even harder, at least in the short term, forcing more savers to turn instead to riskier investments in their search for income and returns.
BUT BETTER NEWS FOR BORROWERS
The biggest impact on the mortgage market is expected to be an improvement in the availability of five- and ten-year loans and their pricing, according to Ray Boulger, senior technical manager at independent mortgage broker John Charcol – provided QE involves the Bank buying long-term gilts.
He said: “This should allow mortgage lenders to offer longer term, say at least ten years, fixed rates at a keener margin over five-year rates than we have seen to date.
“Although demand for longer-term fixed-rate mortgages is fairly small, the closer the rates get to five-year rates, the more borrowers will be tempted to fix for longer.”
As it stands, five-year mortgage rates have already been lowered over the last year, with the cheapest five-year fixed rates sitting around the 4.5 per cent to 5 per cent mark.
But QE could also hinder the recovery of the housing market, some experts believe. More lenders are now offering deals to first-time buyers and QE is unlikely to change that. Yet David Whittaker, managing director of Mortgages For Business, predicted that with QE set to drive inflation up, low interest rates will make it even harder for would-be first-time buyers to save for the deposits they need.
He said: “The number of people reliant on the private rental sector will spiral as a result and professional landlords and property investors will continue to benefit from the ongoing economic environment.”
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