When the state pension was first introduced following the last war the Government promised to look after its citizens from “cradle to grave” through the national insurance system. Working people who retired at 65 were expected to live for between 1 and 5 years on average. Since then due to lower industrialisation, cleaner air and better medical care people are living much longer lives which has increasingly put pressure on the state pension and this means that a typical 65 year old could expect to be retired for almost 15-20 years.
In more recent times people have been encouraged through tax incentives to invest in additional private pensions to give them a boost in pension income when they retire but the take up of these schemes and the amount people pay into them has been relatively low.
The Government has now introduced a minimum pension of £144 which abolishes a lower state pension topped up with additional benefits. For some people who have not made any additional provision this could be a significant drop in income given that the average UK wage is £509 per week and could amount to a drop of almost 70%. Clearly with such a drop of income in retirement new retirees can kiss goodbye to life’s luxuries like a car, eating out or holidays as the minimum State Pension is designed for subsistence living only.
Even where people do make provision, the average pension pot at retirement in the UK is just £30,000 and for a typical 65 this will produce an income through an annuity of only £1,770 per year, not a huge improvement! For those not fortunate to have access to a Final Salary pension scheme, which is increasingly the vast majority of people in the UK, the outlook is very bleak indeed.
Annuities are the investment that people buy with their pension funds at retirement, the income that a typical annuity pays has dropped significantly in recent years from a rate of around 16% in the 1990’s to less that 6% in 2013. One of the main reasons for this is Annuity Companies buy GILTS which are loans to the British Government to provide a safe means of income for their investors. When the Debt Office of the British Government issues new GILT it has to set a rate that will attract investment, but because UK bank interest rates are so low at present, the YIELD offered by GILTS has also fallen. In addition to this Quantitative Easing and the European debt crisis has also put additional pressure on UK GILT yields as they both increase demand.
Hard pressed retirees have also faced another significant disadvantage in recent times, investment performance. The majority of people who save for their retirement in the UK invest in UK Stocks and shares through their pension funds but the investment returns from this area of investing have been exceedingly flat over the past 15 years. The FTSE index which is the measure of the UK’s top 100 companies is at the same level in early 2013 as is was in 1998, a decade and a half later. During the intervening years the FTSE 100 index has on two separate occasions lost around 40% of its value through the recession of the years 2000-2003, with the technology bubble bursting and later in 2008 with the “Credit Crunch” a period of economic downturn that still exists to this day. With the majority of pension funds depending on equities to provide returns over the medium to long term it is hardly surprising that the average UK annuity is just £30,000!
Pension Fund Managers have also struggled to achieve meaningful returns from other forms of investments in recent years. Before the Credit Crunch commercial property funds would regularly return double digit annual growth for their investors. However since the Credit Crunch some property funds have fallen by as much as 40% and have languished ever since. In the past, Pension Fund Managers would move away from equities in times of market turmoil and move a higher proportion of funds into what is deemed as more secure forms of investment such as GILTS, cash and Corporate Bonds. However, as the Bank of England based rate has been slashed to just 0.5% these forms of investment have also struggled to achieve meaningful growth. With the cost of management fees, fund charges and the cost of ongoing advice being deducted from pension funds it is extremely unlikely that the more cautious forms of investments will produce any growth at all. With no growth, the ever present danger to pension funds is the effect of inflation which currently stands at 3.1%; this means that fund performance after charges must at least be this level just for the value to stand still in real terms.
Inflation could pose a higher risk moving forward as the new Governor of the Bank of England has indicated that future focus will be on the recovery of the UK economy rather that the traditional remit of keeping control of inflation. This indicates that UK interest rates will remain low for some time which will of course affect the more secure forms of pension investments; while at the same time inflation could soar meaning higher fund performance is needed just to keep pace with the higher rate of inflation.
There is no doubt that UK retirees are facing the perfect storm with low interest rates affecting pension fund performance and annuity rates, higher inflation eroding pension fund values and pension income and volatile stock markets giving already nervous investors the “jitters.”
Scott Mullen is a founding member and owner of My Pension Expert and has worked as a Financial Adviser for over 14 Years. From 2009 and with the creation of My Pension Expert Scott has specialised in pensions and the at retirement market becoming an authoritative figure around these areas of advice.