Market turmoil ‘has exposed vulnerabilities in the UK’s pension sector’

The economic fallout from last week’s mini-budget has exposed vulnerabilities in the UK’s pensions sector, according to an expert.

The Bank of England has been forced to launch an emergency bond-buying programme to prevent borrowing costs from spiralling out of control, and to stave off a “material risk to UK financial stability”.

The Bank announced it was stepping in to buy Government bonds – known as gilts – at an “urgent pace”.

Alice Haine, personal finance analyst at DIY investing and coaching service Bestinvest, said: “The sharp fall in the value of the pound and rise in the yields on UK Government bonds in the wake of Chancellor Kwasi Kwarteng’s dramatic tax-cutting fiscal plan, set to be funded by Government borrowing, has also exposed vulnerabilities in the UK’s pension sector.

The Bank of England’s decision to step in on Wednesday “shows just how serious the problem is”, she said.

Major changes in long-term interest rate expectations in recent days as borrowing costs have risen have therefore triggered some schemes to demand injections of extra cash to make up potential shortfalls

Alice Haine, Bestinvest

Ms Haine said: “The extraordinary intervention came amid growing concern that defined benefit (DB) pension funds, those where employers are committed to paying retired staff an income linked to their final salary, were at risk of being hammered by the plunge in the value of the pound and sharp moves in the long-term gilts market.”

She continued: “Defined benefit pension schemes need to ensure they have enough assets to cover their future cash flow liabilities far into the future, which is effectively the cost of paying out pension to their retirees.

“Major changes in long-term interest rate expectations in recent days as borrowing costs have risen have therefore triggered some schemes to demand injections of extra cash to make up potential shortfalls.

“With the Bank of England now buying more long-term gilts over the next two weeks, it is hoped this will stabilise the market, but it is effectively switching the central bank’s strategy back to quantitative easing – where it buys bonds and in return injects new money into the economy – at the very point it wanted to focus on QT – quantitative tightening.

“However, the impact of bond market movements on DB pensions is an issue for schemes to address, as ultimately the risk sits on the shoulders of employers, not members.

“These days most people enrolled into a workplace pension will be in a defined contribution (DC) scheme, where the future value of their pension will be determined solely by what they put in and market performance, and not their final salary.

“Pension fund values will also have been impacted by wider turmoil in global financial markets in recent weeks.

“While all of the attention in recent days has been on the pound and UK gilts, people should remember that is set against a backdrop of global volatility.”

This could mean that annuities – which have almost been forgotten about in recent years because of their low rates - will rise like a phoenix from the ashes of the gilt market

Alice Haine, Bestinvest

Ms Haine added: “One positive to take away from all of this is that the rates available on annuities, which provide a guaranteed income for life for retirees if you use your pension to buy one, are getting better all the time, as these are linked to gilt yields, which increasingly is making it more attractive to use at least part of pension pot to buy one rather than putting all in drawdown.

“In theory, this could mean that annuities, which have almost been forgotten about in recent years because of their low rates, will rise like a phoenix from the ashes of the gilt market.”

Baroness Altmann, a former pensions minister, said: “The loss of confidence in sterling following Friday’s fiscal event led to a rushed exit from UK assets, which has accelerated the rise in UK gilt yields.”

She continued: “One of the major problems for the markets was that some UK pension funds, which have hundreds of billions of pounds invested in bonds, had to sell their gilts or other assets.”

She added: “Pension funds can benefit if gilt yields rise slowly… but the speed of the increases resulted in a situation that could have spun out of control and the Bank of England has bought some time for other measures to be considered.”

Ian Mills, a partner at consultancy Barnett Waddingham, said: “The vast majority of DB schemes have successfully navigated this period of heightened volatility and have generally come out the other side in a better-funded position.”

Meanwhile, HM Revenue and Customs (HMRC) figures released on Wednesday showed that the total amount being taken out of pensions has increased in recent months.

Between April 1 and June 30 2022, £3.6 billion of taxable payments was withdrawn from pensions flexibly by 508,000 people.

The average taxable withdrawal was £7,000 in this period.

We could see this increase yet further over the coming months as soaring food and energy prices put pressure on pensioner incomes

Helen Morrissey, Hargreaves Lansdown

This represents a 23% increase compared with the same quarter in 2021, when £2.9 billion was withdrawn.

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown said: “We could see this increase yet further over the coming months, as soaring food and energy prices put pressure on pensioner incomes.”

Jon Greer, head of retirement policy at Quilter, said: “This big jump is likely just the start and more and more people may need to access their pension to pay for their spiralling bills as we enter a fiscally difficult time.

“Although over the last few years the number of flexible withdrawals from pensions has risen, this represents a significant spike.

“During the pandemic, we didn’t see such big increases as the Government support schemes did their job and prevented a mass exodus of savings.

Accessing your pension a few years earlier than planned can trigger a ripple effect into the future that means you may need to re-adjust your future plans

Jon Greer, Quilter

“However, we are now facing a very different beast as energy bills and food costs are set to soar along with mortgage payments, and pensioners may well feel that they need more each month to get by.”

Mr Greer added: “Accessing your pension a few years earlier than planned can trigger a ripple effect into the future that means you may need to re-adjust your future plans depending on what actions you take now.”

Alistair McQueen, head of savings and retirement at Aviva, said: “Events are moving at pace.

“However, most pension savers know that their savings are for the long term.

“Over recent years, pension savers have shown resilience in their navigation of a global financial crisis and a global pandemic.

“Most recently, they have had to weather the financial fall-out from the war in Ukraine and rising inflation.

“This resilience gives me confidence that they can weather today’s storms again. As then, my top three tips remain the same: keep calm; focus on the longer term; and get expert help if you are considering significant action.”