Reality for Retirees – Caught between a rock and a hardplace
QE damages pensions and pension funds – which ultimately harms growth too
by Dr. Ros Altmann
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Anyone recently or soon-to-be retired may be facing a stark reality – Bank of England policy is robbing them of the retirement they saved for. QE is causing dreadful damage to pensions, pensioners and annuities and the impact is long-lasting. Of course, there are some lucky ones, with final salary pensions who are better off, but that is by far the minority.
I believe it is important for everyone to understand the almost impossible position facing older people around retirement today. They are suffering in silence so far, but for how much longer? There is simply nowhere for them to turn – they were led to believe that low rates and QE would be ‘temporary’ policies, but there is no end in sight.
Why is the Bank ignoring these terrible effects on pensioners? Is it because officials don’t realise how many people are being hit and these older people do not have a powerful voice? Is it because most of those making monetary policy decisions have final salary pensions and, therefore, are protected from the impact of their policies?
Most of those who have saved in a pension scheme, other than a final salary-type arrangement, will need to buy a pension income from their pension savings on retirement. They are suddenly finding that the Ban k of England has stacked all the cards against them and there is often nothing they can do to protect themselves. Millions of people who saved diligently for their retirement are now bitterly disappointed with their situation. Such pension problems are being completely ignored by the Bank of England, but they will cause long-term economic damage. QE is supposed to be a temporary boost to the economy, but it is making many pensioners permanently poorer.
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 focussed on buying gilts, this has forced down their interest rates, which has reduced annuity rates, so the pension income people can get from their pension savings has fallen sharply.
Before QE started in 2009, a £100,000 pension fund would buy an annuity (pension income for life) of around £7,000 a year. Now, as a result of the Bank of England forcing gilt interest rates down, 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, so the retiree will be permanently poorer for the rest of their life as a result of QE. This means they will have 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.
Pension companies often impose penalties on people who don’t take their pension in their chosen date:
Some people coming up to retirement now may decide they don’t want to take their annuity yet, due to the fall in rates, but would rather wait and see if rates improve. Some may want to take their annuity early because they fear rates will get even worse if the Bank does even more QE. All these people could find themselves in an impossible position. Pension companies often impose penalties on people who decide not to take their pension on the date they originally selected when they started their policy. Many people will have selected to retire on their 65th birthday, there are record numbers of people reaching 65 at the moment (due to the post-war baby boom) and they may, therefore, find they can only take their pension at age 65, or they will be penalised. They really are between a rock and a hard place.
Income Drawdown also hit by QE
If someone decides they don’t want to buy their annuity now, but would rather wait and hope that interest rates will go up 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 that they are allowed to withdraw from their pension fund 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 own 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). So, if someone was able to take out £5,000 a year income from their pension fund before QE, the Bank of England’s policy on gilt interest rates will mean they can now only take out around £4,000. Even if they had been living on the £5,000 a year in the past, their pension would now have to be cut to around £4,000 because of the new rates. That means they have less money to spend, of course, 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 companies running these schemes are being damaged by the effect of QE. The lower the interest rate on gilts, the worse pension fund deficits become because low gilt rates mean higher pension liabilities. Companies running such pension schemes have to make up the deficits and, as deficits grow, the sponsoring company has to put in more and more money to make up the shortfall. This will harm growth, as instead of using money to grow their business, QE is forcing them to divert resources into their pension funds.
Some companies will go bust as a result of rising pension deficits
Some companies will be unable to cope with the costs of supporting their pension scheme and may end up going bust as a result. This would mean that members of the scheme get reduced pensions when they enter the Pension Protection Fund. Both these factors damage growth.
QE is designed to create inflation which is bad for savers and growth
The aim of QE is to stave off ‘deflation’. In other words to print new money that will create inflation. With UK consumer prices already rising well above the Bank of England’s 2% target, it seems very odd to be pumping more money into the economy now. The effect of 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!
Dr. Ros Altmann