How your retirement income is being killed by other people's pensions
Are you relying on an income-producing investment for your retirement? How about an annuity? Then there's bad news ahead, because both are under threat.
What's going on?
Let's start with those income-producing investments.
Ever since savings accounts started to become so much less rewarding, more and more retirees have turned their attention to 'equity income funds'. These basically invest in companies that have traditionally always paid large dividends, providing an income stream.
Unfortunately, however, one pension investment expert has warned that there's growing pressure on companies to cut these dividends, which could mean a big cut to income payments. This summer we have seen major cuts from the likes of Wm Morrison, Anglo American and Standard Chartered.
Why?
Tom McPhail, Head of Retirement Policy at Hargreaves Lansdown says that a large part of the pressure to cut the dividend comes from a number of black holes in pension funds. The risk posed by a pension scheme black hole came into particular focus this summer with the collapse of BHS, but companies have been agonising over them for a while now.
The main reason these black holes have opened up comes down to the way they are valued - using bonds - the more expensive bonds are, the bigger the hole is measured to be, and bonds are incredibly expensive at the moment.
The reason for this is the record low interest rates. Institutions looking for relatively low risk returns are investing more of their money in government bonds. As demand for these bonds goes up, it pushes the price up.
As a result, the black hole grows, and many firms need to divert a bigger slice of their profits into propping the pension scheme up, so they are cutting the dividend.
It gets worse
For anyone who has invested in equity income - either through a fund or as a holding in their pension - the bad news is that this isn't a trend that's set to change in the immediate future. The recent decision by the Bank of England to cut interest rates still further - to another record low - meant more money going into government bonds, opening up even bigger gaps in pension schemes.
McPhail warns: "We're likely to see more dividends cuts in coming months, unless there is sharp pick up in bond yields."
And annuities?
To add insult to injury, for those planning to convert their investment into an annuity, as bonds get more expensive, annuity returns fall too, so it'll bring down the amount you can make from an annuity.
McPhail suggests the Bank of England issues higher-yielding pension bonds specifically for purchase by annuity providers and pension schemes, which would offer a glimpse of hope in what is otherwise a fairly bleak picture.
