The interest rate cuts announced by the Bank of England earlier in March could lead to reduced pension pot value.
Steve Cameron, of pension provider Aegon, said that the rate reduction would result in a “double whammy” for pensions as annuity rates are also likely to be cut.
The outgoing BoE governor Mark Carney slashed interest rates by half a percentage point to a record low of 0.25pc in response to the coronavirus pandemic. The move coincided with a stimulus package to stabilize and bolster the British economy during this time.
Bad news for pension savers
A fall in the bank rate could lower long-term interest rates, which could then lower annuity rates. This would impact the tens of thousands of people that buy an annuity every year, who are subsequently locked into lower retirement incomes.
“We hope the emergency 0.5 per cent cut in the bank’s base rate will support businesses and consumer confidence through the coronavirus crisis. This should reduce the cost of borrowing for businesses and individuals during what we hope will be a short-term period of disruption,” said Cameron.
“It does, however, pose particular challenges for those approaching retirement. The recent fall in the stock market will mean those whose pension is primarily invested in stocks and shares will have seen their pension pot fall in value.”
Cameron advised that those approaching retirement should revisit their options, such as deferring locking into annuities in the current situation.
“As a result of the pension freedoms, individuals with defined contribution pensions now have flexibility over when they start taking a retirement income and can choose to remain invested, drawing an income, rather than buying an annuity,” he added.
“While there is no guarantee around if and when fund values and annuity rates will bounce back, individuals about to retire might want to seek advice on their options, including potentially deferring locking into annuities at a particularly adverse point in time.”
Taking positives from the situation
According to Tom Selby, of pension provider AJ Bell, pensions are susceptible to a drop in interest rates, but this is not necessarily a bad thing.
As he explains: “Generally lower interest rates are good for equities and therefore pension savers who are invested in equities. Whether or not this action boosts people’s investments or simply acts to stem coronavirus sell-off remains to be seen, however.”
If the bank rate cut pushes the yield on British government bonds lower, final salary or defined benefit (DB) pension schemes could take a hit. A drop in yields would push up the cost of providing pensions, causing schemes to fall further behind meeting their liabilities.
“Given DB schemes were in deficit to the tune of almost £125 billion at the end of February, a rate cut is arguably the last thing businesses who sponsor these schemes need right now,” Selby added.
Those taking an income from their pension under a “capped drawdown” policy would also be affected.