Keep your retirement savings on track
The market turbulence of the past few months has made many people, particularly those nearing retirement, concerned about the damage that’s been done to their pension funds.
There are nearly four million workers in the UK with stockmarket-based company pension schemes. According to a new study by employee benefits firm Aon Consulting, these schemes lost £157 billion – 28% of their total value – over the year to October 2008. To put that into context: a year ago, the average pension pot was worth about £25,000, enough to buy a single man aged 65 a yearly retirement income of £1,960. Today he would receive an annual income of £1,400.
A further 25 million people save into personal pension funds, and they too have seen huge falls. For example, Morningstar figures show the average UK equity income pension fund lost a third of its value over the year to the end of October 2008.
But while such apocalyptic headlines are enough to send anyone with their eyes on a comfortable retirement straight into panic mode, it’s crucial to step back and take an objective look at your personal situation. To help you do this, we assess what the current market crisis means for pension investors, the investment strategies you should be following, and the options available for those of you just about to retire.
20 years or more to go
If you’re less than 40 years old, you shouldn’t really consider switching out of your share-based pension fund.
Hard as it may be to believe right now, the current bear market won’t go on indefinitely and your investments are likely to have plenty of time to recover. The track record of any fund or stock is no guarantee of a repeat performance but, over the long term, shares have almost always performed better than bonds or cash in the bank.
So if you’re still some way from retiring, as IFA Daniel Clayden of Devon-based Clayden Associates says, “you’ve probably got time for another couple of market crashes before you have to worry about drawing an income from it”.
However, while it’s wise to have at least part of your pension invested in shares at this stage, the amount depends on your attitude to risk. Tom McPhail, head of pensions research at advisory firm Hargreaves Lansdown, says: “You can optimise overall returns by simply sticking with an asset allocation of say 70% or 80% share-based investments to 20% or 30% bonds.
"If you go for 100% shares, you raise the level of returns possible, but there’s a higher risk attached but, if you’re 20 years away from retirement, I think shares make sense, provided you get a good mix of different sectors.”
Clayden suggests a balanced approach, including some fixed-interest holdings – for example, Invesco Perpetual’s Corporate Bond fund – and a commercial property fund. He currently likes Norwich Property because it is directly invested in buildings, rather than property company shares which are influenced by stockmarket movements.
Equity funds dominate his portfolio, however, with a mix of UK equity such as Aegon Ethical and M&G Recovery; equity income such as Invesco Perpetual High Income; European and global growth funds; plus a bit in racier holdings such as Gartmore Emerging Markets or Jupiter Emerging European Opportunies, or specialist funds such as JPMorgan Natural Resources.
Bear in mind that, if you are making regular monthly payments into your fund, you’ll benefit from the current low share prices, because your pension contributions will buy many more units at the moment. Considering this, it could make sense to increase your contributions (if you can afford to) so you can snap up the share bargains while prices are low.
10 to 20 years before retirement
There’s still time for a recovery before retirement is imminent, so at this stage it’s often best to stick with your broad-based equity-dominated portfolio, particularly as the market’s still struggling and that would mean you’re likely to make a hefty loss.
“The main thing is not to convert what at the moment are purely paper losses into actual losses,” adds Malcolm McLean, chief executive of the Pensions Advisory Service. “It’s better to sit tight and hope the stockmarket will come back as it always has done in the past.”
Less than 10 years to go
When you have about 10 years before you retire, it’s time to look at all your assets and think about how you will fund your retirement. For the majority of people, it makes sense to use your pension fund to buy an annuity as it offers the certainty of paying a regular income for life.
Make sure in the years just before you retire that your money is not at risk from market disasters, so that you have enough to buy an annuity. You can safeguard your pot by gradually moving it into low-risk investments such as cash or government bonds.
One option available on pensions from many insurance companies is a so-called ‘lifestyling’ facility, whereby a chunk of your pension is automatically switched out of shares and into lower-risk investments each birthday over the last few years before your retirement. However, IFA Keith Churchouse of Churchouse Financial Planning in Guildford is not a big fan.
“‘Lifestyling’ is a computer program triggered on a set date each year, and it takes no account of the markets,” he says. “In the current climate you could easily end up crystallising equity losses when you don’t need to.”
Daniel Clayden agrees: “It’s better to consider the lifestyle facility as an ‘autopilot’ feature, so you’re aware of it going on and are ready to intervene if necessary.”
It’s therefore important to carry out regular reviews and ‘de-risk’ your portfolio manually and strategically over that time and not just rely on the lifestyle program.
You may also decide to keep your pension fully or partly invested in the stockmarket because you want to take the income drawdown route rather than (or as well as) buying an annuity. With an income drawdown plan, your money remains invested and (in theory) continues to grow in value while you draw a regular income.
If you go down this route, you should adjust your portfolio towards a lower-risk profile, perhaps with about 35% in cash or gilts and the rest in a low to medium-risk mix of UK, European and commercial property funds, says Churchouse. This would help minimise the risk should the stockmarket fall when you’re in retirement.
If you’re about to retire and you’re finding that recent stockmarket falls have eroded your pension, there are a couple of things you could consider to soften the blow.
If you have a very small pension pot totalling £16,000 or less, you can take the whole lot as a lump sum, 25% of which can be tax free, rather than buying an annuity which is likely to be worth probably less than £100 a month. This could be ideal if you’re still stuck with unpaid debts – once debt-free you will have more disposable income to live on.
If you haven’t got any debts to pay, you could put as much of your lump sum as possible into an ISA or into a high-interest savings account. That way you would make sure you get as much out of your money as possible. As Clayden says: “You’re better off clearing debts or putting it into an ISA and drawing a good rate of tax-free interest.”
Otherwise, the best thing you can do is to defer doing anything with your pension fund at this stage, to allow the markets some time to recover. This, of course, is easier said than done, particularly as no one really knows how long recovery might take. In practice, deferment may well mean that you continue to work for a while, perhaps part-time.
“A lot of people these days really don’t know exactly when they will retire, and have a pretty flexible attitude,” says Clayden.
If you decide to do this it’s also important to look at all your assets. For example, can you bridge the gap with other savings or investments such as ISAs? It could make financial sense to use up some savings rather than locking yourself into a paltry annuity rate for the rest of your life.
If you haven’t got any savings, consider whether there is any equity in your home that you could tap into. This might involve downsizing, or selling up and renting, or renting out a room for a while. You might even consider an equity release scheme, but make sure the provider is a member of the industry body, SHIP. If you’re unsure of what to do a good financial adviser should be able to help. Visit moneywise.co.uk/findanifa.co.uk to find an IFA in your area. Find an IFA
One big plus of deferring your pension is that annuity rates rise as you get older. According to the Annuity Bureau, a single man aged 65 with a pension of £100,000 could buy an annual income of around £7,850, but a 70-year-old receives over £9,000.
With the current market conditions, McPhail also suggests that one option (assuming you have some other income sources) might be to divide your pension fund and buy a series of small annuities over the next few years, so that some of the money remains in the market.
This way you will spread your risks and become less vulnerable to ups and downs in the market. “On the one hand, it’s likely that annuity rates are likely to fall over the next year as bond yields fall, but against that there’s a reasonable chance that the equity markets will bounce back,” he says.
Help, I’m a final salary scheme member. What should I do?
There has been bad news for the UK’s highly prized final salary schemes too. They guarantee a pension according to the number of years you’ve worked for the organisation; around 8,000 companies offer these, as does the government. But they have been hard hit by falling stockmarkets, with losses totalling £226 billion over the past year, according to Aon Consulting.
Most companies have now closed their schemes to new members, but this has not been enough to plug the shortfall, so many have also tried to cut costs in various ways, including increasing members’ contributions, raising the scheme’s retirement age and reducing the rate at which benefits mount up. Still, there’s a concern some might not be financially strong enough.
According to Tom McPhail, head of pensions research at advisory firm Hargreaves Lansdown, most people don’t have to worry about their scheme going bust because the Pension Protection Fund would guarantee to pay out 90% of their benefits in the event of a collapse.
Those who have to be concerned, however, includes anyone who has pension rights significantly in excess of £30,856 as this is the upper limit for calculating compensation under the PPF. Members of a scheme which is in deficit, or employees suspecting their employer might go bust, should also keep a close eye on what’s happening.
“For some people – but only a few – it may be a good idea to transfer out, though not before seeking independent professional advice. The reality is that, at least for today, the vast majority of people should stay put and not worry about it,” McPhail says.
How to pick the right annuity for you
You could improve your income by about 20% for the rest of your life if you shop around for the best annuity rates. This is because the difference between one provider and another can be huge. Still, the great majority of people don’t bother. Yet it’s easy to find a good rate online through websites such as annuity-bureau.co.uk or the FSA’s Money Made Clear website. Alternatively, a broker specialising in pensions should be able to help you out.
There’s a range of annuity variations on the market. If you have a medical condition such as diabetes or a heart condition, if you smoke or are overweight, you may be eligible for an ‘enhanced’ annuity which pays better rates, so make sure you mention any of the above when searching for an annuity.
You may also want to build in ‘inflation-proofing’ with an index-linked annuity – but be aware that starting index-linked rates are less than two-thirds of the value of ‘level’ (unchanging) rates. If your pension has already been eroded in recent months, you might do better to take the higher-paying level option and look to other savings to boost your income when inflation starts to become a problem.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
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).
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A feature of defined contribution pension funds. As people move closer to retirement, their tolerance to risk reduces. “Lifestyling” recognises this and provides an automatic switching facility from funds with higher volatility to ones with less volatility as retirement approaches. Generally this means the pension fund manager gradually moving a client from riskier assets such as shares into corporate bonds, gilts and cash as they near retirement.
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.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
This refers to a market situation in which the prices of securities are falling and widespread pessimism causes the negative sentiment to be self-perpetuating. As investors anticipate losses in a bear market and selling continues, pessimism grows. A bear market should not be confused with a correction, which is a short-term trend of less than two months. A bear market is the opposite of a bull market.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
A term to describe financial products or ‘plans’ that help older homeowners turn some of the value (equity) of their homes into cash – a lump sum, regular extra income, or sometimes both – and still live in the home. There are two main types of equity release: lifetime mortgages and home reversion plans (see separate entries for both). Whichever type you choose, you borrow money against the value of your property, on which interest is charged, and the loan is repaid when the house is sold after your death.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
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.