The £65billion pension panic shouldn’t stop you saving in your nest egg


Households already have reason to worry. Energy bill ceilings have risen again, property prices are skyrocketing and mortgage rates are reaching levels not seen in more than a decade. Then, last week, fears over pensions got into the mix.

The Bank of England announced on Wednesday it would step in to buy £65bn of government debt to protect pension funds, warning that otherwise there would be a significant risk to the UK’s financial stability.

So what does last week’s turmoil mean for pensions? Are we back to normal, now that a crisis has been averted, or should we still be rethinking when or even if we retire, and how much we can expect to spend in the years to come?

Egg Nest: Are we back to normal, now that a crisis has been averted, or should we still rethink when or even if we retire

Additional protection for gold-plated pensions

The pensions the Bank of England stepped in to save last week were private sector defined benefit schemes – also known as end-of-career wages. These are the most generous, as they pay out a lifetime guaranteed income based on your earnings and have some inflation protection.

Around ten million people in the UK are part of this type of scheme. Although they have largely been scrapped for new members of the private sector, around one million workers in the non-state sector still pay into one.

These pension plans became unblocked last week when the government’s cost of borrowing rose sharply. They use complex financial instruments designed to reduce risk, but which are strongly linked to the cost of public debt. When debt yields rose, pension plans had to quickly start selling assets at ridiculous prices to balance the books.

Although this is a very precarious situation, the important thing is that the Bank of England stepped in to calm the markets and succeeded. This should reassure plan members if things go wrong again.

Also, while these schemes were momentarily under threat, they are basically in good shape. They have more than enough in the pot on average to cover liabilities.

Ultimate responsibility for final pay systems rests with the companies that offer them. If a scheme did not have enough to pay its promises to members, the company would be forced to step in. And if it becomes insolvent, its final salary scheme is taken over by the Pension Protection Fund, so members still receive a pension.

In short, people who have their nest egg in the end-of-career salary plans are very well protected.

What about other workers saving for retirement?

Most workers save in a defined contribution pension plan. If you save by automatic subscription, you will benefit from this type of pension.

Both employer and employee contribute monthly – and the contributions are topped up by the government in the form of tax relief.

Money is invested in financial markets to increase its value. The value of this type of pension is determined by the amount invested and the performance of its investments.

Most savers with these pensions will have seen the value of their nest egg drop over the past year in general, and the past week in particular. That’s because the markets had a terrible week. The value of companies listed on the London Stock Exchange has fallen around 2.5% this week, while an index of the world’s largest companies has fallen nearly 1% – and 25% this year. While it can be tempting to stop saving when markets fall and household bills rise, stopping contributing can lead to future disaster.

Becky O’Connor, head of pensions and savings at investment platform Interactive Investor, says market ups and downs are an integral part of long-term investing.

“Don’t be deterred from continuing with a pension, especially if you’re far from retirement,” she says. “Your retirement pot is for your retirement, and this is your best chance of having one, regardless of what’s happening in the markets right now.”

Market drops can even be good news for young savers who are far from retirement. This is because the investments they buy for their pensions are now much cheaper. Plus, they have time to weather the turbulence and hopefully enjoy long-term growth.

Why drip-feeding your savings is useful

If you’re still contributing to a pension, saving a little regularly is probably a better option than investing in big chunks. By saving monthly, you save through good times and bad in the hope that the price you pay for investments will even out over time.

Investing a lump sum can be extremely profitable if you are lucky enough to invest at the right time. But time it wrong – and no one can really time the market successfully – and you could put all your money in the markets at just the wrong time before a crash.

What about those who have already retired?

Retirees have probably seen their savings hit in recent weeks. For the most part, it would be prudent to stay invested so that savings have time to recover. Withdrawing money from a pension now will lock in any losses and make it that much harder for savings to rebound when financial markets improve.

However, for millions of retirees, this is easier said than done. More and more people are actually withdrawing more from their pensions to meet the rising cost of living.

Between April and June this year, more than half a million people withdrew £3.6billion from their pension pots, a 23% increase on the previous year. Tom Selby, head of retirement policy at investment platform AJ Bell, said: “With millions of families struggling to pay bills right now, for many turning to their hard-earned pensions will seem be the only option.” There will also inevitably be many parents or grandparents who will take part of their retirement income to help the younger generations get by.

Many retirees will have no choice but to dip into their savings to make ends meet. But anyone who can should consider reducing short-term withdrawals to preserve the value of their pot. Some retirees may have to consider postponing their retirement due to recent market declines, or even returning to work if they have recently left the workforce.

Gary Smith, director of financial planning at wealth manager Evelyn Partners, suggests that over-55s who are considering taking a 25% tax-free lump sum from their pension should consider delaying it or taking some part and leave the rest invested.

“Withdrawing the tax-free lump sum takes a large chunk out of one’s retirement savings early in retirement, or even before, and the diminished pot is then likely to provide meager income over the remaining lifetime to retirement,” he said.

“Many pension funds have performed poorly this year, so taking a lump sum now will likely mean crystallizing losses rather than letting investments recover. This could deal a double whammy to his personal wealth.

But there is good news…

Savers looking for guaranteed income for life will find they can get a much better deal after the recent market turmoil. Annuity rates have risen nearly 40% this year so far, thanks to rising interest rates and government bond yields.

A 65-year-old pensioner with a lump sum of £100,000 can buy an annuity with an income of around £6,600 a year for life. At the start of the year they were said to have received no more than around £4,800.

Annuities have fallen out of favor in recent years because the income they offered was so modest that savers thought they could produce a better income by keeping their savings invested and drawing upon them as needed.

However, with rising annuity rates and the security they provide, annuities are starting to look a whole lot better.

And, to further reassure pensioners, Chancellor Kwasi Kwarteng pledged on Thursday to maintain the triple lockdown of state pensions.

This ensures that the state pension will either increase in line with inflation, wage growth, or 2.5% – whichever is higher.

With inflation around 10%, the full annual public pension is expected to top £10,000 for the first time in April next year.

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