People using their savings to secure a guaranteed income when they retire will be worse off as a result of the EU referendum, after insurers once again cut annuity rates.
Standard Life and Legal & General both announced rate cuts this week, pointing to the fall in gilt yields following the vote in favour of leaving the EU.
The yields on ten-year UK government bonds are used as the basis for the pricing of both annuities and final-salary pension payouts. But those yields have plummeted to a record low since the referendum and annuity rates are now heading in the same direction.
Other insurers are expected to follow Standard Life and Legal & General with rate cuts of their own over the coming days and weeks, particularly if the Bank of England embarks on more quantitative easing (QE).
David Smith, director of financial planning at Tilney, said: “With a very clear signal that further interest rate cuts are on the cards, and possibly another round of QE, UK gilt yields are now at an all-time low.As pension annuities are directly linked to gilt yields, the amount of income a retiree can secure from their pension has already fallen significantly and a further QE stimulus will only serve to compound the problem.”
The cuts came a week after Prudential dealt a blow to pension savers by walking away from the open market, meaning it will now offer annuities only to existing customers. The options open to people shopping around for the best annuity deal had already been reduced by the merger last year of Just Retirement and Partnership.
The number of people using their pension savings to buy annuities has fallen sharply since the pension reforms of April 2015. Many retirees now enter drawdown instead, where they remain invested and take income from their fund in tranches.
But the post-referendum volatility has sparked renewed fears that many people who have gone into drawdown since the pension “freedoms” took effect could now be draining their funds at a faster rate than they realise.
That’s because anyone taking the same level of income from their fund while its value is being reduced by market falls risks suffering the effects of “pound cost ravaging”.
“Those in drawdown particularly need to consider pound cost ravaging as it means more funds need to be sold to achieve the same income eroding funds more quickly,” explained Rachel Vahey, an Edinburgh-based pensions consultant. “The reduced funds have little potential to bounce back if markets rise, instead locking in the loss.”
Urgent action may be needed in response to the latest volatility, so it’s vital to review your drawdown investments to see if any changes need to be made to the investment mix.
“On first glance we may think that the market response to the referendum has been benign, with FTSE returning to pre-referendum levels, but a closer look shows some areas and stocks have been hit hard,” Vahey pointed out. “People need to make sure they have a diversified investment approach to help them weather the storms.”
Drawdown investors should also review income levels and possibly reduce their income or stop it altogether to ensure their fund doesn’t lose too much value.
That may involve calling on other sources of income, but for many people that will be difficult at best.
“You may need that income to live your life now. In this case you should review which funds are being cashed in to pay for the income you’re taking,” said Vahey.
The biggest challenge is faced by the considerable number of people who have entered drawdown without taking advice.
“Those without advisers and invested in default funds may take some comfort that these will be changed to help achieve diversification and steer away from unsuitable stocks,” said Vahey. “But this is where we can see the real potential and positive of getting regulated financial advice.”
Investors who have been advised should have a diversified asset allocation which is appropriate to their time horizon, attitude to risk and income requirements, according to Paul Lothian, co-director and chartered financial planner at Verus Wealth in Dundee.
“If that’s the case we would not advocate making speculative tactical changes or running for “safety” during this uncertain time. That said, our pension drawdown clients are encouraged to suspend or reduce their withdrawals during periods of falling prices and we allocate at least 12 months worth of income to cash each year.”