Scots approaching retirement must take action to mitigate the effects of low interest rates, or risk getting a raw deal for their savings, experts warn.
The slim prospect of interest rates rising all but disappeared when new Bank of England governor Mark Carney signalled this week that rates will remain unchanged until the unemployment rate falls to 7 per cent or lower.
The base rate seems certain to be left at 0.5 per cent until at least 2016, the earliest point at which the Bank believes that jobless numbers will drop to that level.
By March 2016, the 0.5 per cent rate will have been in place for seven years, prolonging the agony for savers who have seen billions wiped off cash returns in recent years but keeping mortgage costs down for homeowners.
But it’s not just savers and borrowers that are affected, with implications also for pension investors, older workers and retirees.
For those with a few years to retirement, Carney’s announcement provides added incentive to boost their pension pot. That may mean people taking more risk with their investments to compensate for low savings returns and poor annuity rates.
Nigel Green, chief executive of the deVere Group, said: “Therefore, it might be time for more pensioners and pre-retirees to bite the bullet and consider reducing holdings of cash and bonds and increase exposure to portfolios of well diversified, higher risk-higher return investment opportunities. This could potentially enable them to fully enjoy their mature years by maintaining their spending power.”
The good news for those with a few years in which to boost their pension savings is that they could benefit from the positive effect of low interest rates on equity returns.
However, the biggest challenge faces those on the cusp of retirement and planning to buy an annuity, with which the majority of people convert their pension savings into a regular income in retirement. Annuity rates have hit record lows over the past two years, pushed down by the effects of quantitative easing on gilt yields, on which annuity rates are largely based.
And while Carney has indicated that QE will wind down, experts warn that annuity rates are unlikely to rise while the base rate is unchanged. Many people have been holding off buying an annuity in the hope that rates will improve, with a rise last month in gilt yields offering rare encouragement.
“Interest rates remaining at 0.5 per cent is likely to maintain the pressure on annuity rates,” said Julie Russell, of Standard Life. “How annuity rates move in the future is very difficult to determine because annuity pricing is complex and multiple factors make up the rate – investment return from the asset backing the income payment, servicing costs, how long people live.”
She warned against trying to second-guess movements in yields and annuity rates. “It can be a risky thing to do,” said Russell.
Paul Gibson, Aberdeen-based chartered financial planner at Carbon Financial Partners, said: “Some commentators have recently suggested deferring buying an annuity predicting that annuity rates will rise.
“This now seems less likely in the short term, given the forward guidance that the Bank rate will remain at low levels until at least 2016 – unless unemployment falls quicker than expected, or inflation gets out of hand.”
With the average pension fund worth around £30,000, the default choice for most people at retirement is buying a one-off annuity. That makes it even more important to get the best possible deal by shopping around for an annuity rather than immediately accepting the existing pension provider’s offer.
The best annuities provide an income around a fifth higher than the least valuable, so the effort of looking for the most suitable deal can make a considerable difference to retirement finances. Those with lifestyles or health conditions that may reduce their life expectancy can qualify for enhanced annuities, which typically pay out a higher income.
People with large pension pots may be better off phasing their annuity purchase, said Gibson, or opting instead to leave their fund invested and take income from it in tranches, in what’s known as income drawdown.
“For those with larger funds, a more pragmatic approach often adopted is to purchase annuities in stages and provide a base level of guaranteed income to meet essential expenditure and take a more adventurous approach with the balance using income drawdown or investment based annuities,” he said.