What does Brexit mean for pensions?
Following the news that the UK has voted to leave the European Union we ask what impact the move will have on your pension, whether you are years away, approaching retirement or already retired.
For savers in defined contribution schemes:
As the value of a defined contribution pension is directly linked to the stock market, members of these schemes will see the value of their savings drop on the back of the Brexit vote. Within minutes of opening the FTSE 100 lost 500 points with some banks falling by as much as 30%. But Tom McPhail, head of retirement policy at Hargreaves Lansdown is telling savers not to panic.
“For long term pension investors who may be seeing the value of their retirement savings falling today, the key message is to do nothing unless you have to,” he says. “We are likely to experience a period of volatility in the markets and uncertainty in the wider economy, in these conditions, acting in haste is unlikely to serve well. If you are years from retirement and making regular savings, then just keep going; falls in the market mean buying investments at a lower price.”
The news will be more worrying to savers who are closer to retirement and may not have time to make up significant losses. However, Mr McPhail still urged against making hasty decisions. “If you are close to retirement, then try to avoid selling funds and shares right now. Annuity rates may move in response to changing interest rates, however this is not certain. International and domestic demand for Gilts and Sterling denominated investment grade bonds will influence annuity rates, as will expectations of inflation and to a lesser degree, short-term interest rate movements.”
For those investors that have already retired and are drawing an income from their savings, Mr McPhail recommended limiting withdrawals to ensure remaining capital is not eroded further. “A good default strategy is to draw the natural yield (dividends from equities, interest on fixed interest stocks) as this means you aren’t cashing in the capital value of your investments at a time when they are falling in value.” He suggests that this is likely to be between 3% and 4%.
For members of defined benefit schemes:
Defined benefit schemes pay members an income based on their salary and the length of their membership and as such are not linked to stock market performance in quite the same way as defined contribution schemes. However, that is not to say they are sheltered from volatile markets as the assets required to cover their liabilities will be invested. According to Hargreaves Lansdown some 33% of all UK schemes is invested in shares, of which 25% is in the UK. Problems in the wider economy may also make it more difficult for employers to meet their funding commitments. Mr McPhail adds: “If the economy does now start to stall or even contract, then corporate profits will be hit and this in turn could lead to further funding issues for employers. The only good news is that a falling exchange rate may help these businesses to export their way back to profitability. “
What about pensions tax relief?
Following a lengthy consultation the Chancellor turned down the opportunity to change tax relief on pension contributions in this year’s Budget. However, Mr McPhail says this savings sweetener will remain an easy target. “Pension tax relief costs the exchequer billions every year and there may now be increased pressure to balance the Budget; the government top up to our retirement savings could be an early casualty. The current Chancellor George Osborne had threatened an emergency Budget in the event of a Leave vote. Whether this happens or not, the possibility of further curbs to pension tax relief has now increased, so investors would be well-advised to make the most of the available tax relief while they still can.”
Is my state pension safe?
During the referendum campaign, David Cameron warned that the triple lock on state pensions could be put at risk in the wake of a Brexit vote. This is because the policy – which ensures the state pension rises by the greater of earnings growth, increases to the consumer prices index or 2.5% - could become too expensive to maintain during a down turn. Mr McPhail says: “According to analysis conducted in 2011, the cumulative cost of the Triple Lock, relative to the old RPI link, between 2011 and 2026 would be £45 billion. If the Chancellor does now carry out his threat of a scorched earth Budget, then the Triple Lock could be an early casualty.”
However, Steve Webb, director of policy at Royal London says: “It would be odd for a government to prioritise a cut which would affect the most powerful voting bloc in the country.”
Tom Selby, senior analyst at AJ Bell also warns that there could be problems for British pensioners living in the EU as well as those that might be planning to retire there. He says: “Brexit could have severe implications for almost 500,000 UK pensioners living in Europe, or those who are planning to retire to the continent.
“At the moment, state pensions for those living in the EU are uprated in line with the triple-lock. However, leaving the EU casts doubt on whether this valuable benefit will continue as the UK may need to strike individual deals with each member state – presuming the Government doesn’t remove it altogether.
According to analysis from AJ Bell, a 65 year old retiring on the flat-rate state pension of £155.65 a week would miss out on at least £50,000 of income over 20 years without the triple-lock.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.