Retirement savings have been thrown into the spotlight after the Bank of England made an emergency intervention amid fears that some pension funds were at risk of collapsing.
There have been signs of relief across the financial markets after Kwasi Kwarteng was sacked as chancellor. New prime minister Rishi Sunak has also brought relief to the market.
But many people have been left wondering what all this turbulence means for theirpensionsavings and what they need to do toprotect their precious nest eggs, especially withinflation exceeding 10%.
This applies both to those who are fast-approaching retirement, as well as those with money invested for retirement further down the line.
We take a look at:
- Why did the Bank of England intervene last week?
- How does the pound affect pensions?
- How does bond buying affect pensions?
- Is my pension at risk?
- How can I protect my pension from market chaos?
- I’m retiring soon – are there any precautions I need to take?
What happened with bonds, gilts andpensionfunds?
After Kwasi Kwarteng’s mini budget on 23 September, the pound plummeted and tremors rippled through the financial markets.
As part of an emergency intervention the Bank stepped in to buy government bonds to help calm the market (we explain why later in this article).
The Bank then gave a bond-buying deadline of Friday 14 October, raising fears that this could cause a “cliff edge” reaction that could exacerbate the financial chaos. There have been calls for it to extend its intervention beyond Friday to give pension funds more time to respond.
The reason this is an issue is because some pension funds are linked to government bonds, also known as gilts.
What is a gilt?
Pensionfunds were put at risk after there was a massive sell-off in gilts following Kwasi Kwarteng’s mini budget on 23 September. The former chancellor has now been replaced by Jeremy Hunt.
When you buy a gilt, it’s like an IOU from the government as it seeks to raise money for its spending programmes. A recent example was the borrowing needed to support its coronavirus support packages.
You acquire a piece of the government’s debt and receive fixed interest payments, perhaps twice a year, over the life of the bond before getting your original capital back at the end of the term. This could be anything from under a year to 30 years. The interest paid on bonds is known as the “yield”.
Say you have invested £1,000 in a government bond and the rate of interest is set at 5% – that means you receive regular payments of £50 on that gilt investment.
Why did gilts affect pension funds?
Gilts are traded on the open market. So the tax-cutting plans announced in the mini budget caused concern among investors who saw borrowing increase and lost confidence in the government’s ability to pay back this debt. This prompted a sell-off in gilts and caused their values to plunge.
This in turn meant yields soared. This is because if, say, that £1,000 bond was now valued at £800, the guaranteed interest payment of £50 would represent a new, higher rate of 6.25%.
This sell-off threatened a meltdown infinal salary pension schemes which tend to own a lot of gilts.
These defined-benefit workplace schemes differ from defined-contribution pensions in that they promise to pay out a set retirement income to individual pensioners based on salary and length of service and not on the investment performance of the money contributed to a scheme. In other words, all the risk is with the fund provider.
That risk was amplified in the aftermath of the mini-budget as yields surged. Pension schemes needed to rapidly sell their gilts or other assets to fund their income promises to scheme members.
But they were selling into a falling market – where the supply of gilts was not matched by demand from investors willing to step in and buy them. So their ability to offer a guaranteed income to scheme members was in jeopardy and their continued existence was put into doubt if they were no longer solvent.
Why did the Bank of England intervene?
In an unprecedented £65 billion move, the Bank of England stepped in to buy government bonds. This will provide some price support for pension schemes and calm the volatility.
The aim was to try and calm the market with a controlled and time-limited intervention. The Bank was successful in bringing gilt yields down, helping to reduce the volatility and to protect the solvency of final salary schemes.
The aim was to try and support the economy with a controlled and time-limited intervention.
However, the markets started panicking again after the Bank of England governor Andrew Bailey said that pension funds had just three days, until 14 October, to resolve the issues.
New chancellor and PM brings relief to the markets
Government bond yields started to recover on 14 October after Jeremy Hunt replaced Kwarteng as chancellor.
Hunt reversed most of the changes announced in the September mini-budget. We go into more detail.
Markets appear to be relieved by the changes, with gilt yields falling.
Investors hope that having a veteran cabinet minister in charge of the public purse will help to get the country’s finances on a sustainable path.
Gilt yields fell again as Rishi Sunak became the new prime minister. Yields dropped to levels last seen before the mini-budget. The fall in yields will reduce the government’s borrowing costs.
How does the pound affectpensions?
After the mini-budget value of the pound plummeted to a 37-year low against the dollar as people lost confidence in the UK government. On 23 September one pound dropped below $1.08.
When the pound tumbles this can lead to turbulence in the markets. For example, UK importers and manufacturers that source parts from overseas have to pay more for their purchases, and their stock prices may be marked down accordingly.
This can affect the return on your investments, such as shares.
Read how fluctuations in the pound affect you.
Sterling fell again below $1.07 after the International Monetary Fund (IMF) sounded the alarm over UK plans to cut taxes in themini-budget.
The pound then regained some ground against the dollar, mainly because of the Bank’s move to restore financial stability and the government U-turn on the scrapping the 45p rate of income tax. As of 10 October, one pound would buy you $1.13.
But the pound has fallen back to $1.10 after Bank of England governor Andrew Bailey said it would not extend its emergency support. Pension scheme bosses are now asking for more time.
Even so, the pound remains under pressure.
How does bond-buying affectpensions?
By stepping in and buying bonds, final salary schemes, held by many in the public sector, were rescued.
As these are more heavily invested in gilts, they are more exposed to fluctuations in prices.
The Bank’s move was aimed at preventing gilt prices from falling too far.
What does all that mean forpensionfunds?
The central bank’s decision to buy government bonds should restore some calm and stability to markets.
However, final salary scheme trustees have been urged to keep the resilience of their investment strategies under close review.
So is my final salarypensionsafe?
If you’re a member of a final salary (defined benefit) scheme, you should feel reassured by the action taken.
Provided the employers sponsoring the pension schemes remain solvent, there is no risk of members’ pensions not being paid in full.
If you’re in a defined benefit scheme and your employer goes bust, your pension is likely to be protected by the Pension Protection Fund.
What if I’m not in a final salary scheme?
Most workplacepensionsare nowdefined contribution schemes. This is where the value of thepensionis determined by how much money is put in and the investment returns.
This includes employees who contribute a percentage of their pay into their pension every payday through the auto-enrolment scheme. Through this scheme workers receive contributions from their employers and tax relief from the government on top.
With defined contribution schemes, money is often invested in a mix of financial assets, such as shares and bonds. But the assets chosen and the proportions allocated to each one will vary depending on your pension provider and what fund you are invested in.
For example, if you get a high rate of growth, the fund might take higher risks with your money by stocking up on shares compared to fund with a low rate of growth.
As you get closer to retirement, some savers will find that they have a higher proportion of bonds in their pension portfolio, which are seen as less risky compared to assets like shares.
If any of your pension is invested in bonds then you might have seen the value of your nest egg drop over the past few weeks. It’s not been a smooth ride for the stock markets either, so most pension savers will see big swings in the value of their pension funds.
How can I protect my workplace and personalpensionfrom all this market chaos?
If you have apension that isn’t invested in government bonds, you will not be directly affected by the Bank’s move and should continue to save as normal.
You should continue to contribute into your workplace pension scheme. If you opt out then you will miss out on tax relief and your employer’s contributions.
Remember that apensionis a long-term investment and as part of this, markets will rise and fall.
The idea is that by leaving your money invested, the value of the assets will grow once again and so you will be able to ride out the downturns.
Read more: Money’s tight, should I pause paying into my workplace pension?
I am retiring soon – are there any precautions I need to take?
If you are over 55 but still working and don’t need yourpensionmoney, resist the temptation to grab as much out of your pot as you can to put in a savings pot.
Remaining invested over the long term – usually five or more years – is your best bet tobeat inflation and protect your money from market falls. You also risk sabotaging your pension income if you sell out at a time when the value of your investments is falling.
Whilesavings ratesare rising, they are still a long way from the current rate of inflation of almost 10%. Find out the best savings accounts.
Bear in mind that, even though things are hard now – with many expecting a protracted downturn – the markets will start rising again. Of course we can’t say when that will be but you may not have to wait too long for yourpensionpot to start looking healthier again.
That said, it may be worth taking this opportunity to review the risk level of your portfolio:
- If you are about five years from retirement, reducing the level of risk could be sensible
- For those a long way off retirement, it might be better to stay in a higher proportion of shares in your portfolio to try to benefit from the market recovery when it comes
If you can, consider working for a bit longer, so that you can keep your contributions and tax relief going for another few years.
This would tide you over what’s expected to be a rough patch economically, while also allowing you to buy more shares when prices are low. This in turn could give your pension pot a boost.
Find out: Nine ways to give your pension a boost
I’m a long way off retirement, what should I do?
Oliver Rose, an IT consultant from Shrewsbury, is anxious to know how the recent market turbulence has affected hispensionsaving.
The 29-year old holds a self-invested personalpension (Sipp) with investment platform, Interactive Investor. He puts his money into a spread of well-diversified funds which cover a range of different geographies and sectors.
He focuses on rapid growth areas such as US technology and emerging markets.
Oli, a keen runner who raised money for Cancer Research and Mind in the latest London Marathon, said: “Amid this turmoil, part of me wonders whether or not to continue with apension, but I have to keep reminding myself that market highs and lows are all part of long-term investing.
“As it’s likely to be a few decades before I retire, I can hopefully ride out this latest turbulence.”
If you are a relatively young saver with a decent way to go until you stop working, you should keep contributing to your pension.
You could even find the market falls work in your favour, as your contributions could be buying investments more cheaply than a year ago – making it cost-effective.
With time on your side, you should also be able to ride out the downturns and benefit from growth over the long term.
Read more: We round up the best ready-made personal pensions.
Your questions answered
We asked Rebecca O’Connor frominvestment platform, Interactive Investor (ii), to help answer your questions:
My “cautious”pensionfund is mostly in government bonds and gilts: should I transfer to a wholly cash fund while the market is so volatile?
The risk of moving your pension money into cash isinflation. This could be a bigger risk than the under-performance of bonds and gilts which, while still volatile, have stabilised a bit.
Savings accounts pay 2.81% for easy access. A cash fund in an investment account may pay even less. High inflation will be with us a while longer.
If the security of cash makes you feel safer, moving a part of your portfolio across may give some comfort. But do consider keeping as much as possible invested. Selling out of investments only crystallises losses that, until that point, are notional.
The value of mypensionhas declined in the past couple of months. I’m invested in a range of things. Should I stay put, or consider changing my mix?
Many of us are more engaged with ourpensionsthan ever, but when markets are struggling, it can mean more people may unduly worry.
You should avoid taking drastic action on the back of what has happened to markets recently.
Whether you change your risk profile should really depend on how far you are from retirement. If you are decades away, continuing to take some risk – in exchange for the prospect of higher growth – is still acceptable.
Multi-asset funds remain the mainstay of apensionportfolio. They contain assets such as shares and bonds which have little correlation with each other. In other words, when one goes down in value, another is likely to be going up.
Over the long term, this strategy has proven effective against inflation.
I have apensionpot and would like to start takingan income from it because I’m having to dip into my savings to manage. Is this a bad time to do it?
In all honesty, it isn’t a great time. If you have no choice but to raid yourpensionfor income, do so as sparingly as possible.
Perhaps consider putting off treat spends. Now is the time for careful budgeting and circ*mspect income withdrawals. It might be better to take income from your savings.
Also be mindful of how yourpensionor savings income is likely to be taxed. There are different rules depending on how you take income out of yourpension, and how much you take from your savings – as well as your taxpayer status.
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