Feature: Lower pots and higher anxiety

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pensions

Lower pots and higher anxiety

Richard Tomlinson reports on how the economic downturn has hit people’s retirement plans as they have to budget for massive unforeseen expenses and funding shortfalls

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Charlotte, 62, an experienced state school primary teacher looking forward to retirement, could have done without the drop in her income in 2018. She had become unhappy with the working conditions at her north London school and decided to resign. For the next two years, Charlotte (not her real name) had several part-time teaching jobs, earning substantially less than her previous £51,000 salary, until in September 2020 she took another full-time position paying £45,000 per year.

She counts herself fortunate that despite suffering a hit to her earnings between 2018 and 2020, her final salary pension under the state Teachers’ Pension Scheme will be based on the average of the best consecutive three years in her last decade of service. “The final salary teachers’ scheme is really good,” says Charlotte, who is married to a self-employed businessman and has two grown-up children. “I should have enough money to live on quite well, if it’s combined with my husband’s personal pension.”

People with access to their pensions feel they have to use their funds to help their children

In normal times, Charlotte’s relative optimism about her pension would scarcely be noteworthy. She is typical of millions of people in their fifties and sixties who have managed their financial affairs prudently, with the odd hiccup along their career path, in the expectation of a secure retirement. But these are not normal times.

Since March 2020, the UK has experienced the most severe quarterly recession for almost a century, a sharp recovery between July and September, a slowdown in the fourth quarter, a drop in the base rate to 0.1%, rapidly rising unemployment and massive government borrowing. Some economists have begun to consider the possibility of stagflation, where inflation and unemployment remain high while the economy does not grow.

In a matter of months, the Covid-19 turmoil has drastically intensified concerns among baby boomers that their pension pot may have to cover massive expenses that were never part of their original retirement plan, such as long-term care and paying for their children’s mortgage. “There is this sense of extreme strain emerging, where people with access to their pensions feel they have to use their funds to help their children,” says Rebecca O’Connor, head of pensions and savings at Interactive Investor, the online personal finance platform. “At the same time, they are really anxious about not having enough money left for their retirement.”

These anxieties are highlighted by Interactive Investor’s 2020 Great British Retirement Survey of more than 12,000 adults of all age groups. One in five of pre-retirement respondents between 60 and 65 say they will need to carry on working longer than they had intended because of the pandemic’s economic impact. More than half of retired parents in the survey have helped their children with a house deposit, while two in five have gifted them money, often by drawing down pension pots faster than they anticipated.

Covid-19 has also forced UK pension fund managers to accept that their previous forecasts about the impact of low interest rates on future returns were probably too optimistic. The Universities Superannuation Scheme (USS) is a prime illustration. It is the UK’s largest private pension fund and one of the few defined benefit schemes in the private sector still open to accrual. In its post-war heyday, USS was the kind of plush, final salary retirement fund that enabled academics to think big thoughts on modest incomes, safe in the knowledge that their pension was secure.

Not any more: since 2018, USS has been locked in a bitter three-way dispute with members and universities about how to meet past promises about final salary defined benefits. In the year to 31 March, 2020, USS’s funding deficit – the difference between the sum available to pay retired pensioners and their defined benefit entitlements – more than doubled to £12.9bn, even though its assets under management were worth a colossal £67.6bn. Much of the damage was caused by the pandemic’s impact on financial markets in the first quarter of 2020 and its balance sheet was stretched further over the spring and summer.

In September 2020, USS announced that to cover a potential deficit of anywhere between £9.8bn and £17.9bn, total annual contributions might have to rise as high as 67.9% of salaries. With some understatement, USS conceded that this scenario was “unlikely to be considered affordable or sustainable” by members or their employers.

Hope tempered by caution is probably the best formula for plotting a path towards financial security in old age

“USS is saying to the universities that if you don’t want to pay these extremely high contributions, you are going to have to strengthen your commitment to supporting the scheme, if and when it gets into trouble again,” says Ben Waltmann, an economist at the Institute for Fiscal Studies who co-authored its 2020 annual report on education spending in England.

The problems of defined benefit schemes such as USS in the wake of Covid-19 are the concern of a privileged minority who are sufficiently lucky or canny to have a final salary pension. For the majority of employees with defined contribution pensions, it is the possibility of losing their job that poses the most immediate threat to their retirement plans. In the three months to October, 370,000 people were made redundant, pushing the official unemployment rate up to 4.9%.

Holly Mackay, chief executive of Boring Money, an online personal finance platform, predicts that deepening financial insecurity will also mean “more people opting out of schemes and losing employer contributions. This will bite in a few decades’ time when a younger cohort comes to retire.”

The value of financial advice

It is easy to continue in this gloomy vein and conclude that, for most people, any prospect of a secure pension has been obliterated by a decade of austerity and low interest rates, culminating in an economically devastating pandemic. Yet it is arguable that the current upheaval has simply reinforced the need to follow conventional wisdom about planning for retirement: think long term, seek the best advice and take personal responsibility for investments.

Jo, a 62-year-old former senior executive in industry, has tried to follow these rules. She retired last summer after a successful career spanning 35 years at a range of companies in the north of England. With a husband who has also retired and two grown-up children, Jo’s future income depends on several different sources. She will benefit from only 10 years’ worth of final salary pension because only two of her employers operated final salary schemes that were open to new entrants. The remainder had money purchase schemes with varying eligibility criteria.

Jo (not her real name) reckons she will probably get a combined annual income of about £30,000 from the final salary schemes, although one is now in the Pension Protection Fund, reducing her future pension to 90% of what it would have been. The rest of Jo’s retirement pot will depend on how well her investments perform from her money purchase schemes, which she has actively managed. She believes that having been a trustee of her previous employers’ company schemes gave her privileged access to the best investment advisers, as well as helping her develop a rounded, informed view of how to manage investments for the long term. Jo has no illusions. She knows double-digit annual returns will never come back and is aiming instead for an average 2-3% on the remaining pot.

“I’m an optimist, so I think I’m going to live for a long time,” she says, “So I’m concerned that my guaranteed retirement income from my final salary pensions won’t be enough to maintain my lifestyle and I’m going to have to be careful about how I draw down my pension pot from the money purchase schemes.”

Hope tempered by caution is perhaps the best formula for plotting a path towards financial security in old age, in an economy that will take a long time to recover from Covid-19.

Richard Tomlinson

Richard Tomlinson is an international business writer and historian who has written extensively about France. He is a former correspondent for Fortune magazine in Asia and Europe and the author of Late Shift: the death of retirement, a book about the UK’s corporate pension crisis