How to prevent your finances being dashed on the rocks by the eurozone storm

FOR THOSE of us watching anxiously from the sidelines, the uncertainty only deepens as the eurozone crisis rumbles on. With politicians continuing to dither and fears growing of a double-dip recession, the implications for savers, investors, homeowners, borrowers and retirees continue to unfold.

You might expect the greatest repercussions to be felt by private investors, as every twist and turn in the saga sparks more market volatility, yet stock markets have remained largely resilient.

However, falling gilt yields are dragging down pension payments and pushing mortgage rates up, and while it’s anyone’s guess what happens next, investors and savers are moving with growing urgency to protect themselves from the worst of the potential fallout.

Here are a few ways in which you could be hit by the eurozone drama – and how you can respond:

PENSIONS

The long-term slide in the income paid by annuities has accelerated in recent weeks. As overseas investors have turned to UK gilts as a safe haven, the price of those gilts has risen, pushing down the yields; and those yields (along with corporate bonds) dictate the pricing of pension annuities.

When gilt yields fall (as they also did when the government launched its latest quantitative easing programme) pension companies slash the income they pay on annuities.

A 60-year-old man retiring now and using his £100,000 pension pot to buy an annuity from the most competitive provider on the market would get £400 less than if he had retired just three months ago, according to the Alexander Forbes Annuity Bureau.

Annuity rates are now at all-time lows and seem certain to fall further before stabilising, never mind recovering lost ground, leaving those retiring in the near future with something of a headache.

Paul Lothian, director at Verus Financial Planning in Dundee, said now isn’t a good time for buying an annuity. “If this decision can be deferred by either working a little longer, spending capital, buying a short-term five-year pension annuity, or entering pension income withdrawal, then these options should certainly be considered,” he said.

Brian Steeples, managing director and chartered financial planner at The Turris Partnership in Glasgow, agreed. He said: “If you need to take your pension now you could buy a limited-term annuity, which would provide you with income for a specific term, such as five years.

“At the end of the five years you would be able to look at the rates on offer at that time. If rates are still quite low, you could buy another limited-term annuity, leaving yourself with another option further down the line.”

Phasing annuity purchase is one option, as Lothian said, while retirees should ensure they shop around for the best deal at retirement, rather than immediately accepting the offer from their existing pension provider. Smokers and those in ill-health may also qualify for “enhanced” annuities, which pay out a higher income on the assumption of reduced longevity.

While the vast majority of retirees buy an annuity, some can afford to leave their pension invested, using income drawdown arrangements. But even here lower gilt yields are having an impact, reducing the maximum income that can be taken. The gilt yield that is used to calculate drawdown limits plunged to a record low last week, reducing the income rate for those entering drawdown or having their maximum income level reviewed next month.

The problems don’t stop there. Many pension funds also hold gilts and as prices rise and yields drop, even more pressure piles on companies with final-salary schemes. Most have closed to new entrants, many to existing members, and that trend could accelerate as lower returns force employers to divert more money into their funds.

MORTGAGES

The effect of the rurozone crisis is now set to feed through to mortgage borrowers, with suggestions that mortgage costs could rise as a result of the turmoil. The reason is a recent rise in the London Interbank Offered Rate (Libor, the rate at which financial institutions lend to each other) as confidence dwindles in the ability of European banks to repay each other. The tracker rates being offered to new customers have already gone up, with Santander and the Halifax, the UK’s biggest lenders, increasing their rates.

Steeples believes mortgage rates can now go only one way.

“If you have a big mortgage, you can future-proof your budgeting by switching to a fixed-rate mortgage. This is effectively you taking out insurance against future increases in interest rates. Your premium is the slightly higher interest rate you pay just now for the fixed rate.”

SAVINGS

The eurozone crisis means the Bank of England is now unlikely to raise interest rates next year, prolonging the misery for millions of savers who have suffered inflation-ravaged returns over the past three years.

Lothian said: “I think we all need to get used to the idea that low savings interest rates might prevail for some considerable time. The best way to achieve above-inflation returns is to commit some capital to long-term growth assets (particularly a well-diversified holding in equities) and to take a long-term view. This comes at the price of high levels of volatility, so should be done only in the appropriate measure.”

And there are other concerns, including the potential consequences of an escalation of the eurozone’s troubles on the security of savings deposits.

The golden rule is to avoid holding more than £85,000 with one financial institution (not brand). This is the maximum that can be covered under the Financial Services Compensation Scheme (FSCS).

Some of the names around the top of the savings best-buy charts are relatively unfamiliar to UK savers. So while most are covered by the FSCS, always double-check. Those not covered by the FSCS, including ING, operate instead under a passport scheme (provided they are in the EU) whereby the host government is responsible for some of the compensation that might be due to savers. The best-known example is Landsbanki-owned IceSave, UK customers of which had a long wait for their money after the provider went bust three years ago.

Steeples said: “If you are really concerned about banks going bust and you have substantially more than £85,000 to ‘protect’, an offshore investment bond is worth considering. If you invest in the ‘internal cash fund’ of the host provider, you benefit from protection of 90 per cent of your money, with no upper limit.”

INVESTMENTS

The market turbulence of recent weeks hasn’t featured the precipitous losses that many feared, but investors have moved to minimise the risks to which they could be exposed should the crisis escalate.

Yet if you’re investing for the long term – such as for retirement – it’s important to keep your eyes on the horizon.

Lothian said: “We don’t know the future, but we do believe that holding your nerve and staying in the market is the best course of action for most. Time is the healer, and it’s time that allows markets to deliver the returns that investors are due for committing their capital.”

The best way to manage risk is to ensure you don’t leave all your money in one basket. Spreading it across different asset classes – equities, bonds, cash and property, for example – is one of the fundamentals of good investing.

But if you do want to find a shelter from the financial storm, there are alternatives. Gold has been one of the most popular options for those wanting a hedge against inflation and a way out of the markets in recent months. Even gold hasn’t been immune from the wobbles, however, with fears over the euro and the strengthening of the US dollar seeing gold prices slip from their recent highs.

Index-linked gilt funds, which invest in AAA-rated inflation-linked UK government bonds, are another alternative. An investment in the index-linked gilt funds in any four-year period over the past 11 years would have produced inflation-beating returns above those from cash, according to Steeples.

“This period covers two stock market crashes and shows the resilience of these types of funds. Our view is that index-linked gilt funds are an excellent core holding in most portfolios, irrespective of inflation and interest movements.”