QE damages pensions and pension funds – this will harm growth, not boost it!
by Dr. Ros Altmann
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As the Bank of England announces yet another extension of its ‘Quantative Easing’ (QE) programme it will cause more damage to pensions, pensioners and annuities. QE is designed to use newly created money to buy Government bonds (gilts). The increased demand for gilts aims to drive down interest rates, which is supposed to stimulate the economy by increasing bank lending. The policy of ultra-low interest rates and large-scale money printing was supposed to provide a ‘temporary’ fillip to the economy, but there is no end in sight. So far, QE has done precious little to boost growth, but it has certainly boosted inflation and has also damaged pensions. Low government bond yields mean lower pensions as the money paid out from annuities and income drawdown policies falls. Anyone recently or soon-to-be retired is at risk of having the retirement income they saved for taken away from them by Bank of England policy.
So why has QE been such a disaster for older people?
Annuity rates have fallen as a result of QE.
The majority of people with personal pensions (not final-salary type schemes) buy an annuity on retirement which provides their pension income. The amount of income they will receive from their accumulated pension savings is determined by the interest rates on Government bonds (gilts) – the lower the interest rate, the lower the pension income paid. As QE has forced down gilt interest rates, annuity rates have fallen. In fact, since 2008, annuity rates have fallen by around 25%.
In other words, before QE started, a £100,000 pension fund would buy an annuity (pension income for life) of around £7,800 a year. Now, a £100,000 pension fund would only buy an annuity pension income of around £5,800 a year. Once the annuity is bought, it lasts for the rest of the person’s life, making pensioners permanently poorer for the rest of their life as a result of QE. This gives them less money to spend and, with around half a million annuities sold each year, there will be a significant permanent reduction in spending power in our economy.
Income Drawdown also hit by QE
If someone decides they don’t want to buy their annuity now, but would rather wait and hope interest rates will rise again in future, they do have an option (depending on the size of their pension fund) to take a quarter of the fund as tax free cash and leave the rest of it in an income drawdown policy, from which they can take an income each year. However, the amount of income they are allowed to withdraw is set by the Government Actuary’s Department (GAD) and the lower the interest rates on gilts, the less the income people can withdraw from their pension fund. (The aim of the restriction is to ensure people don’t run out of money, but the fall in GAD rates means that pension incomes have fallen sharply following QE). This is leaving many pensioners with less money to spend, which will harm the economy.
Savings income has fallen sharply due Bank of England policies
As interest rates have fallen, older people living on their savings have suffered significantly. Many were relying on income from their savings to top up their pension income, but find that monetary policy has hit their savings as well as their pensions.
Company pension schemes hit badly by QE too
Anyone with a final salary pension is much better off than those with other types of pension fund, however the lower the interest rate on gilts, the worse pension fund deficits become because low gilt rates mean higher pension liabilities. As scheme deficits have soared, companies running such pension schemes have had to divert much more money to make up the shortfall instead of using money to grow their business, which is again bad for growth.
QE is designed to create inflation which harms savers, pensions and growth
The original aim of QE was to stave off ‘deflation’, by printing new money to create inflation and the inflation rate has been more than double the official 2% target. Nevertheless, the Bank of England has still decided to print even more money, keeping interest rates low and damaging real returns for savers and pensions. The combination of high inflation and ultra-low interest rates (as the Bank of England forces interest rates down via QE) is toxic for savers. Interest rates are below inflation rates, so each year the value of their savings falls. And 90% of pensioners have bought a fixed annuity which pays an income that does not increase in line with inflation. So, as inflation rises each year, they become poorer and poorer. This will harm longer term growth, as the over 65s become an ever-increasing proportion of the population.
The sooner the Bank of England recognises the long-term dangers of continuing with QE, the better all our futures will be.