PENSIONS IN THE CROSSHAIRS
The economic fallout from the pandemic is sure to have a huge effect upon our pensions, says Bill Jamieson
Finance guru Bill Jamieson warns that our pensions pots may take a beating in the wake of the pandemic
At what time did you stop looking? Such has been the colossal hit to pensions and longterm savings by the COVID-19 pandemic and consequent economic carnage that many will have shut their eyes as stock markets plunged and our seemingly secure savings nest eggs were battered.
At one point in late March the FTSE100 index of leading shares had crashed 32% from its precoronavirus January level of 7,674 to 5,190, a collapse of almost 2,500 points. The FTSE250 index comprising medium-sized companies – which is more representative of domestic companies exposed to changes in the UK economy – fared even worse, falling 38% in barely two months.
Now most pension savings will not have experienced such dramatic declines. The investments have been spread across different asset classes, and many will be heavily weighted towards bonds and fixed interest stocks which have not been so badly hit.
But nonetheless, most will have an equity exposure of some sort – and given the experience of the past decade, some will have preferred to be overweight in shares, particularly when the yield on fixed interest savings has hit new lows.
But this has now come to a juddering halt. And if the immediate shock was not bad enough, it has been compounded by a sense of helplessness that there was little we could do to protect our savings.
The worst seems to be over for now. Since the bleak days of late March, there has been a partial and fragile recovery, trimming the loss on the FTSE100 to 23% by early May, with a similar upturn for the FTSE250.
But we are still deep in the danger zone, with the attendant risk of a second coronavirus peak as we stagger out of lockdown. And even assuming we negotiate the next few weeks without relapse, the road to recovery is set to be long and arduous. How then can we take steps to make good at least some of the losses suffered?
Amid the immediate rush to protect jobs across the economy, with more than nine million workers likely to be furloughed, there has been confusion over what happens to the implications for pensions. If companies are paying a reduced salary to those on furlough, the pension contribution is likely to be reduced as a proportion of this reduced salary. There may be exceptions to this stance, but not, I fear, that many.
The government will only cover the autoenrolment minimum pension contribution of 3% for furloughed staff, at the lower of 80% of their salary or £2,500 per month. Many companies pay more than 3% in contributions and it will be up to them whether they make up the shortfall.
The Job Retention Scheme does not cover any of the employee’s contributions. Those struggling for cash may be tempted to opt out of auto-enrolment and be automatically re-enrolled in three years’ time. But be mindful here that the employer’s contribution will be lost, and it is best to pay continuously into a pension.
Nathan Long, senior analyst at Hargreaves Lansdown, says that from a pensions perspective, being furloughed will have little impact on retirement prospects over the long term. A three-month blip may make little difference but if contributions are reduced over two to three years the damage will be that much greater.
For those on defined benefit schemes, the government has made no specific recommendation. Here the definition of final remuneration is important as it could affect your pension if you are on furlough and approaching retirement.
No less worrying has been the impact on those relying on company dividend income to help them
in retirement. In recent weeks, dozens of companies have announced that dividends and share buybacks will be scrapped, suspended or delayed. According to an analysis by investment platform GraniteShares, between 19 March and 20 April, around 92% of UK-listed companies had cancelled or suspended dividend payments. In total there were around 176 dividend announcements during this period.
The firm says investors will be hit hard by dividends being cancelled or suspended. It adds: ‘Reinvesting them and the benefits of compounding mean they are one of the most powerful tools available for boosting returns over time.’
But it also adds this comfort: ‘While the coronavirus will likely continue to rattle markets, this doesn’t necessarily mean longterm investors should be overly concerned. This is because volatility in the stock markets is normal and markets often rebound quickly once immediate issues are resolved.’
And as Tom Selby, senior analyst at broker A J Bell points out, at times like this, ‘anyone investing in the stock market should be thinking in terms of five years or more, rather than weeks or months, and that is the context through which to view the current turbulence.’
Pension savers should also watch how withdrawals from a pension pot can affect income tax liability. We are allowed to withdraw 25% of our pot free of tax, and the rest is taxed as income when it’s withdrawn at our ‘highest marginal rate’ at that time. This could mean you pay 20%, 40% or even 45% on such income if you are a UK taxpayer or 21%, 41% or 46% if you are a Scottish taxpayer.
If you take out a large amount of your pension in a tax year – or even cash in the whole pot – this could push you into a higher tax bracket, resulting in you paying more tax than you would have if you’d taken smaller amounts out over a longer time period. Moral: delay taking your pension, if you can.
Best surely say some, amid all the coronavirus chaos, to avoid shares and bonds and stay in cash. But cash can fall victim to the silent killer of inflation. There may seem little risk of this now but may pose a real threat as governments have to face the consequences of extraordinary levels of debt.
At present, the average rate of interest on an easy-access savings accounts has fallen from 0.56% in March to 0.44% in April. But what matters is the real rate of interest after taking inflation into account. The Consumer Prices Index (CPI) currently stands at 1.7%. Take this into account and the real return is minus 1.26%. At that rate, cash savings are eroded by a quarter over 20 years.
And negative interest rates have been a persistent fact of life in Britain. Prior to the 1980s the real rate of interest regularly dipped below zero. In 1975 real rates reached minus 10%. In the past decade, by contrast, real rates have oscillated between minus 1% and minus 2%. If inflation kicks off, we could soon be back in the days of much higher negative interest rates.
And according to a paper by Bank of England economist Paul Schmelzing in January, real interest rates have been falling for six centuries, from a peak 9% in the 1400s to 3.4% in the 1800s and 2% in the 1900s. So far in the 2000s they have averaged 1.3%.
And with governments so heavily indebted and thus a chief beneficiary of inflation to bear down on that burden, there is the risk that negative real rates of interest will persist in the future. Cash savers do not escape the pain – they could prove its greatest victims.
“Withdrawls from a pension pot can also affect income tax liability