How will the UK’s economic recovery affect pensions?

Laura Miller

by , Freelance financial journalist

at PensionBee

25 June 2021 /  

June 2021

Many people walking down Buchanan street in Glasgow, Scotland

The UK’s forecast to grow at the fastest rate since WW2 this year - but amid stock market volatility and rising inflation, pension investors will need to diversify their investments to maximise their chance of seeing their retirement pot grow too.

How has the economy performed so far this year?

The UK economy is beating predictions so far in 2021, helped by the big rise in COVID-related public spending in the March Budget. “Having suffered the largest economic contraction in modern times, the UK now looks set to grow in a manner this year that will also break records,” is the National Institute of Economic and Social Research (NIESR)’s assessment.

Re-opened restaurants, pubs and non-essential shops are booming; retail sales jumped 9.2% in April (42.4% higher than a year earlier amid the first lockdown). Better sales at company tills and a thriving UK economy should boost pension funds that invest in UK firms, growing your retirement pot and income.

Even if your pension is entirely invested in Britain’s main FTSE 100 index, around 70% of FTSE 100 companies’ income is generated overseas. Luckily, the latest figures from the International Monetary Fund (IMF) estimate that the world economy is also set to perform better than forecast, this year.

Good news for pensions, so far - though the rebound is largely due to trillions in government support, a tap that will eventually have to be turned off.

How have pension funds performed?

More investment risk means a higher chance of better returns – but also losing it all.

The average pension fund grew by 4.9% in 2020, arguably not bad amid a global shutdown. But this compares to 14.4% in 2019. PensionBee’s plans consistently outperformed the FTSE 100 last year, with the majority of funds growing by more than the average rate. Average annual annuity income also fell last year, for the third consecutive year, by 6.3%.

In May, average yearly annuity income rose by £86 to £2,357, according to Moneyfacts. But in May 2019, yearly income was £2,516 - so today, retirees are still getting £159 less on average.

To make up for the shortfalls, pensioners withdrew £2.6 billion from their pensions during Q1 2021, up 6% year-on-year according to HMRC. One in three (35%) 41-54-year-olds plan to delay retirement by 16 months, according to research conducted by the team at PensionBee.

Where’s the economy heading now?

With ongoing government support and the vaccine rollout, the IMF expects the world economy to grow by 6% in 2021 (up from its 5.5% forecast in January) mainly due to a big upgrade for the US economy.

In the UK, NIESR has sharply revised up its forecast for 2021 economic growth to 5.7% (from 3.4%), with 4.5% forecast for 2022. From the worst performer among G7 countries in 2020, “optimism about the UK recovery is broad-based and well-founded”, NIESR says.

But the cost of living is also rising. NIESR expects UK inflation to reach 1.8% this year, and almost 2% after 2023. The Bank of England could react by raising the base rate to keep a lid on inflation. Interest rates and inflation, as well as economic growth and how well individual companies perform, will affect pension funds and any cash held in the bank.

How can you secure your financial future with a pension?

Low interest rates at a time of rising inflation eats into the value of savings sitting in cash or cash-like investments like our Preserve Plan, a problem for cautious retired people looking to avoid stock market losses.

At the same time, some fear that stock markets - which have soared since their March 2020 lows - are overvalued and due a fall. Then there’s inflation, which could slow consumer spending and/or force the Bank of England to raise rates sooner.

For pension investors, higher interest rates can mean:

  • investors dump stocks for less risky, interest-bearing bonds, sending share prices lower, reducing returns for pension funds
  • the value of their pension funds fall - pension schemes are one of the largest investors in bonds, and bond prices tend to fall when interest rates rise
  • transfer values on defined benefit schemes tend to fall when the base rate rises

But it isn’t all doom and gloom, higher interest rates can also mean:

  • buying an annuity gets better value, with higher incomes offered
  • increased opportunities to invest at lower prices

When markets fall, it’s tempting to consider withdrawing your money to protect it or moving it to lower risk investments, however, there’s a risk that investments could be sold at a loss and you may miss out on any increases in value in the future when markets recover.

On the contrary, when markets aren’t doing well, there are more opportunities for investors. If you make regular contributions to your pension, you may wish to increase your contributions as you’ll be able to invest at lower prices.

As ever, it’s important to remember that pensions are a long-term investment and although it can be uncomfortable, short-term fluctuations are unlikely to cause any lasting damage, especially if you have no plans to retire in the next few years. That being said, those in or approaching retirement may wish to only draw down what they need and lower their income withdrawal rate to a maximum of 4% a year to avoid running out of money.

The outlook for the UK and global economy is good but uncertain. Pension funds are likely to perform better than last year during the extended lockdowns. However now could be a good time to review your pension investments and ensure they’re well diversified across different geographies and asset classes, as well as ensuring they meet your long-term investment objectives.

Risk warning: 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.

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