So Brexit is underway and the newspapers are focused on backstabbing in Parliament, the first signs of how the economy is responding, and how the geopolitics of Europe are shifting. But of course, the big question is – how will the Brexit referendum impact you and your pension?
The short answer: Brexit’s impact on your UK pension is negative. If you have a defined-contribution (DC) scheme, weaker investment returns will likely slow the growth of your pot. If you have a defined-benefit scheme, that ‘risk-free’ income stream now has some credit risk attached to it. Let’s go over what’s happened and what you can do to protect your retirement plans.
Brexit & Defined Benefit
As you know, defined benefit plans promise pensioners a fixed income, which means the plan sponsors themselves take on investment risk. They need investment returns to be high enough to grow the contributions they receive into a big enough pot to keep their promises. They’ve already been suffering rather badly with global interest rates at all-time historical lows since the 2008 financial crisis. And with the Bank of England dropping rates even further to prop up the economy in the wake of the Brexit referendum, the outlook is now even worse.
According to the Financial Times, over 80% of private sector DB schemes are in deficit, with hundreds of companies facing bankruptcy over their liabilities. Brexit itself increased total estimated deficits by around 14%! The BT, British Airways and RBS pension schemes are among the most vulnerable.
What to do: It’s unusual to recommend leaving a DB Pension, even one that is in trouble. That’s because it’s normally unlikely that the pot you receive could earn you anywhere near the income you are currently promised. However, the drop in rates means that transfer values – the size of the pot you receive in exchange for leaving a DB pension – have now soared. That means that transferring out of a DB scheme – once an unthinkable recommendation – might now, in certain situations, be conceivable. There’s no going back, so it’s a decision to be considered extremely carefully and with the help of an expert.
Even if that is not your case, it is time to stop looking at DB pensions as risk-free. In your financial planning, actively consider a scenario in which your pension folds and whether you would have enough assets and income in other places to meet your basic objectives.
Brexit & Defined Contribution
The challenge for DC pensions is similar – investment returns are likely to be poor. The difference is that here you have less of an ‘all-or-nothing’ scenario. You won’t fret whether your pension implodes – you’ll just wish it grew faster.
What to do: Fortunately, with DC pensions, you are (or can be) in control to protect yourself. If you have a ‘run-of-the-mill’ pension with high fees, mediocre investment performance and an overly UK-centric portfolio, it’s time to move.
You may either need a Self-Invested Personal Pension (SIPP) or, if you qualify for one, a Qualifying Recognized Overseas Pension Scheme (QROPS). This will allow you to partially make up for low interest rates by saving on fees (and possibly taxes in the case of QROPS).
It will also let you manage your risks whichever way you are most comfortable, in order to obtain satisfactory returns. If you can tolerate some variability, you might want to invest more heavily in stocks. If you want better interest rates and more comfortable with higher risk, you might want to go for bonds issued by emerging-market governments or more indebted companies, for instance.
Brexit & Nearing Retirement
If you are nearing retirement and considering buying an annuity, it might be best to wait. The income you are promised in an annuity is calculated based on interest rates – the lower the rate, the lower the income you receive.
Forecasting interest rates is no easy task, and there is no indication that rates will rise in the short term, but common sense says that betting that rates will stay low or fall further, when they have just hit their all-time low and are very close to zero, might be unfortunate.
Brexit & Working Towards Retirement
If you are in the beginning or middle of your career, you need to be aware that, although you were lucky to born into an age of extraordinary advances in technology and medicine and with declines in wars and crime, you got a rather raw deal on the pension front.
DB schemes are on their way to extinction, the rates you will earn on your private investments are comparatively low, government pensions and services around the world are likely to come under increasing strain and, to deal with that, they are likely to tax you at higher rates.
So fight back! Be frugal and build a war-chest to keep you safe and to be able to invest heavily when opportunity does eventually knock. Don’t tolerate high fees or sub-par returns on your investments. Opt for the tax structures that most effectively legally minimize your tax bill.
In summary, Brexit is likely to have a negative impact on pensions. However, now is an excellent time to take action to improve your retirement prospects and minimise problems.
