What will 2017 bring for our pension funds?
What does 2017 hold for our pensions? 2016 was a rollercoaster year for the markets and economy, with a knock-on effect for investments and pensions – but can we expect an easy ride in 2017? Here Stuart Price, Partner at Quantum Advisory, looks ahead at t
Inflation Based on recent market data, an increase to inflation is something the markets are now expecting, with predictions of a rise of up to 4% in the second half of 2017.
An increase in inflation is not good news for UK defined benefit pension schemes, as pensions generally increase each year in line with inflation and an increase in inflation means that a higher value is placed on defined benefit liabilities.
This, compounded with a low interest rate, means that the deficits of UK defined benefit pension schemes are expected to get even bigger than they are at the moment.
Some ways pension schemes can help to protect themselves (known as hedging) against inflation include:
■ Putting in place a liability driven investment (LDI) mandate.
This enables pension schemes to use inflation swaps so they pay a fixed rate of inflation and receive whatever inflation turns out to be.
■ Invest in assets where the capital value and income are linked to inflation.
These are known as ‘real assets’ and examples include index linked bonds and infrastructure.
However, unlike a LDI strategy, which closely matches the pension liabilities, the main drawback with these assets is the accuracy of the inflation hedge. Interest Rates In his Autumn Statement Chancellor Philip Hammond announced further government spending intended to stimulate the economy, but this is likely to keep interest rates lower for longer.
Savers and pension schemes continue to struggle with very low interest rates, and this looks likely to continue in 2017.
Expected price inflation will also cause difficulty for savers and anyone on a fixed income. Money purchase annual allowance The Chancellor also reduced the amount someone can save tax-free into a pension, from £10,000 to £4,000 per year, if that person has already withdrawn just a cash sum from a defined contribution pension. This would reduce the pension savings allowance for some individuals to a very low level, and will require careful thought from anyone thinking of taking just a cash sum from their defined contribution pension while still working.
Taking a lump sum for example to pay for a holiday, could severely restrict someone’s ability to save again into their pension for the rest of their working life. State pension triple lock There had been speculation before the 2016 Autumn Statement that the Chancellor might scrap the ‘triple lock’ that links State pensions to the higher of earnings increases, CPI (consumer price index measure of inflation) or 2.5%, but the Chancellor confirmed that this will remain until at least 2020.
The triple lock offers very strong protection to pensioners receiving State Pension and maintains the value of their State pension over time, but many still see it as a way to buy pensioners’ votes which will become unsustainable in the long term. Pensionable age A rise in the state pension age is currently under Government review and could mean that those under 55 at the moment receive their state pension a year later.
Transparency about plans for the state pension age will be key in ensuring workers can effectively plan for their retirement. Global politics 2017 promises to be as equally as tumultuous as 2016. The Eurozone faces extraordinary political risks, with elections in the Netherlands, France and Germany, where right wing populist parties are expected to perform strongly.
Investors should be prepared for unprecedented levels of volatility. However, as we saw with the both the EU referendum and the US Presidential election, market reactions can reverse quickly, so short term positioning around certain political events could prove counterproductive.