Unless you’ve been steadfastly avoiding financial news (we wouldn’t blame you!) you’ve probably heard a lot about spiralling government borrowing costs in recent days – but you might not be aware what impact these can have on your pension.
UK government borrowing costs, otherwise known as gilt yields, have soared this New Year, with the yield on 10-year gilts reaching its highest level since 2008, whilst 30-year gilts yields hit their highest level since 1998. In very simple terms, the price of gilts falls and yields go up if more investors are selling rather than buying the gilts that are already on the market.
Yields have risen due to a combination of international and domestic factors, with a jump in US government bond yields having a significant knock-on effect on bonds worldwide. Yields have risen in the US amid concerns surrounding President-elect Donald Trump’s plans to introduce trading tariffs. Nearer to home, higher inflation in the UK, combined with concerns about the state of government finances, have both helped push up yields here.
This might all sound a million miles away from your retirement savings, but higher gilt yields could leave many pension savers who are nearing retirement worse off. Conversely, it could benefit those planning to use their pension to buy an annuity, or guaranteed income for life, who may end up with a higher income than they might have previously.
Here, we look in closer detail at what falling bond prices could mean for you and your retirement savings.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
What do falling bond prices mean for your pension?
Falling bond prices can be bad news for those whose pensions are invested in ‘lifestyling’ funds. With this type of fund, your retirement savings are gradually moved away from shares to lower-risk investments (normally a mixture of bonds and cash-based accounts) as you approach retirement.
The lifestyling process normally starts between 15 and five years before you reach retirement age, although this will depend on the provider and the fund you’re invested in.
The logic behind lifestyling is that as it reduces your exposure to the ups and downs of the stock market, this should hopefully avoid the risk of your pension savings plummeting in value just before you need them. However, recent bond market volatility has essentially flipped that wisdom on its head, with bond investors now nursing losses as a result of the latest sell-off.
Commentators are urging pension savers not to panic, but current turbulence should serve as an important reminder to regularly review where your pension savings are invested. Laith Khalaf, Head of Investment Analysis at AJ Bell, said: “The typical gilt fund is down 2.5% in the last three months, while the typical pension lifestyling fund is down 4.4%, as these invest in longer dated bonds. To put this in some context, in 2022 these funds fell by 24% and 36% respectively. We’re very, very unlikely to see such deeply negative returns given yields are starting from a much higher level, and bonds are also now paying some income, which can offset capital losses.”
You can find out more about lifestyling in our article What is pension lifestyling? and why it’s crucial to check where your retirement savings are invested in our guide Where is my pension invested?
What impact is the gilt yield surge having on annuities?
An annuity is essentially a contract with an insurance company. In return for handing over some, or all your retirement savings, you’ll be paid a guaranteed income for life, or a fixed term. However, this income usually dies with you, and so can’t be passed onto loved ones.
Annuity rates are affected by a variety of factors, such as gilts and interest rates. With gilt yields soaring in recent days, annuity rates have also been steadily increasing.
According to Hargreaves Lansdown, a 65-year-old with a £100,000 pension can now get up to £7,425 a year from a single life level annuity with a five-year guarantee. This is up from £7,235 a year last week and up a massive 48% on the £5,003 that was on offer this time three years ago.
Helen Morrissey, head of retirement analysis, Hargreaves Lansdown: “We could see further income rises in the weeks to follow and this could push incomes up to the highs we saw in the aftermath of the mini-Budget.
“Annuities continue to provide great value, and we can expect to see interest in them continue to increase, with many retirees deciding that now is the time to take the plunge and get a guaranteed income for life. However, it is important to look before you leap. Once bought, an annuity cannot be unwound and different providers offer different rates. If you take the first quote offered without checking the rest of the market, you may find you’ve made a costly mistake. Using an annuity search engine can help you check the market quickly and easily before you make a decision.”
Find out more about why it’s crucial to shop around for an annuity in our article Why it pays to shop around for your annuity. It’s important to remember that you don’t have to use all your pension savings to buy an annuity. You might decide, for example, to use some of your money to buy an annuity to cover your living expenses, but to leave the remainder invested so you can draw down your savings as and when you need them. Learn more in our guide Annuity vs drawdown: which is right for you?
Tom Selby, director of public policy at AJ Bell, said: “Your health and lifestyle are key, both when annuitising and taking a flexible income through drawdown. If you have limited life expectancy then you might be able to get a better ‘enhanced’ annuity rate. Similarly, in drawdown, if you have a shorter life expectancy you might be comfortable withdrawing more. However, you still need to be confident your pension pot will survive as long as you do.”
A final thought…
Spiralling government borrowing costs might be concerning, but it’s important not to make any knee-jerk decisions. For tips on managing challenging times such as these, read our article Four ways to weather stock market storms. If you’re not sure whether your retirement savings are affected by current volatility, or you need help deciding whether an annuity or drawdown is right for you, you may want to seek professional help.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.