Pensions have been in the news a lot lately. This is a time of great national anxiety and retirement worries can become especially pronounced when we witness economic turmoil and disruption around us. I’ve had the opportunity to discuss the latest developments with some of our customers and thought I’d share my thoughts here in case they’re useful to others. In sum, this has been a rocky time in financial markets, but there are opportunities for savers to enhance their future retirement readiness and strategies to help mitigate some of the negative effects of the external economic environment on pension pots today.
First of all, let me mention that the majority of newsflow at the moment is focused on defined benefit pensions, which reflect the promise of an employer to pay a final salary to former employees. Because of an array of accounting rules and associated investment strategies, many of these pension schemes have engaged in complex derivatives that are generating a need for them to sell assets, such as bonds and equities, in order to meet the collateral calls of their trading counterparties. The Bank of England has had to support pension funds by buying these assets. In short, while the situation sounds precarious and indeed may be for some of the institutions involved, the current consensus view is that there is little additional risk to the actual pensions that pensioners are receiving or may receive because ultimately the promise of the employer is intact and even if the employer’s promise falters, the Pension Protection Fund stands ready to step in.
While there is little direct impact on defined contribution pensions, such as the PensionBee Personal Pension, financial markets are interlinked and the chaos in the defined benefit pensions market has rattled global capital markets, which do indeed affect defined contribution pensions. This year has been particularly challenging for equities, bonds and the pound owing to interest rate tightening and the war in Ukraine, all of which would have contributed to declining pension balances with all pension providers in the country. Indeed, the only way to have avoided a balance drop this year would have been to invest in some combination of cash and commodities, an unlikely and highly risky approach to pension investment. Commodities are known to be volatile investments and cash itself would likely have had a negative real return after the effects of persistently high inflation in 2022. While poor pension performance across the whole country is likely to be of little consolation to those nearing retirement, it’s important to recognise that these types of economic environments, and their consequent impact on pensions, generally cannot be avoided. On the contrary, they’re considered to be a part of pension investments and one of the reasons why pensions have long-term returns of about 7% per year. Eventually markets will recover.
So given the current situation, what can and should you do? Well that depends. If you’re far from retirement and still mid-career, generally speaking, the accepted approach is to ride it out. If you’re closer to retirement and can even withdraw your pension, you may be wondering whether it’s better to simply take your pension money out and put it in the bank, thereby avoiding the losses of any additional market drops. That is usually not a good idea because you will ‘lock in’ your loss and miss out on the eventual market recovery. If you can wait until the recovery, your pension may be better served. You may also wonder whether you should switch plans, perhaps moving to a cash-like, lower risk plan. Again, this is a personal decision, but it’s important to consider that a loss is likely to be locked in and a lower risk plan will usually come with lower returns (that is why it’s a lower risk plan). If you must withdraw from your pension plan, it’s considered good practice to withdraw as little as possible so as to leave as much invested to take advantage of the eventual recovery. In the meantime, it’s important to be aware that markets could fall further, so you must be comfortable with your decision.
Finally, you should consider whether you can increase your pension contributions. It may seem counterintuitive, but in periods of downturn markets are often referred to as being ‘on sale’. Because markets tend to recover over the long-term, this may be an opportunity to invest in your retirement while prices are low and take advantage of the subsequent recovery. How long that may take is still unknown, but bear markets do occur throughout history and you can consider some analysis on averages and extremes.
Pension decisions are personal and this commentary should not be regarded as advice, but it’s in line with the guidance provided to pension companies by the Financial Conduct Authority during times of downturn. Take the time to think about which approach works best for you and to map out a financial plan that matches your expenditure, your opportunity to save and your pension withdrawals (if you’re able to make them). If you are over 50, speak to Pension Wise. As always, we at PensionBee are here to support our customers.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.