As we pass a decade since the financial crisis first emerged, its consequences are still revealing themselves.
The focus of debate has shifted from the imminent threats to the country’s finances, such as its borrowing deficit and credit rating, to the less obvious, but no less troublesome, damage done to the fortunes of individuals.
Wage rises below the rate of inflation and lower returns from financial markets have conspired in a hidden squeeze on households, and news analysis from Fidelity reveals how this is hitting those retiring now, in particular.
In fact, those hitting retirement today must cope with pension income that is potentially 46%1 lower than could have been expected had they retired immediately before the credit crunch.
This represents the combined effect of a real-terms fall in wages, lower market returns and greatly reduced returns on annuities, which provide secure retirement income, in the decade since the credit crunch first emerged.
Fidelity modelled the outcome today facing someone who was ten years away from retirement in 2007. They were earning £45,000 at that point with a £50,000 pot of pension savings already amassed and contributing an ongoing 12% of their salary to a pension.
Their salary was uprated through the period using an average from ONS Annual Survey of Hours and Earnings data and their pension contributions were added to their pot and invested. At the end of the period in 2017, their pension pot was used to buy an annuity at current market rates.
The results were then compared to the outcome achieved had they experienced the conditions prevalent in the preceding 10-year period, from 1997 to 2007.
The results show that, by all measures, those retiring now have suffered compared to their counterparts retiring a decade previously.
|Salary at start of period:||45,000||45,000|
|Salary at end of period:||63,242||53,220|
|Annualised CPI inflation in period:||2.60||2.702|
|Pension pot at start of period:||50,000||50,000|
|Pension pot at end of period:||180,107||139,110|
|Income from average annuity based on pension pot:||12,193||6,6073|
|Replacement rate (of pre-retirement income)||19.30%||12.40%|
The earlier cohort enjoyed 3.5%4 a year pay rises across the period, compared to inflation of 2.6%, making them richer in real terms.
By comparison, those retiring in 2017 have seen their salary grow by just 1.7%5 a year, versus inflation of 2.7%, making them poorer over the period in real terms. In our scenario, the difference this makes is £43,156 of missed earnings across the decade.
Lower earnings has meant lower pension contributions, and those retiring in 2017 in our model would have been able to pay in £5,179 less over ten years thanks to lower pay compared to the preceding period, but this has been compounded by worse market returns as well.
Invested into a portfolio of shares and bonds (60/40 global equity, global bond), those retiring today will have seen their pot grow to £139,110. Had they enjoyed the higher contributions and better growth offered by the 1997-2007 period, their pot would have swelled to £180,107. Please remember past performance is not a reliable indicator of future returns.
The income they can buy
It’s no surprise that the lower pension pots of those retiring today secure them less income in retirement. But they have suffered even further from lower rates on annuities, the insurance product that pays a guaranteed income for life in exchange for your pension savings.
Annuity rates have been a casualty of monetary policy since the crisis, which has been to reduce the Bank of England rate, dragging rates on government bonds down with it. These are the assets underpinning annuities, so the returns retirees can get has fallen in lockstep.
Additionally, the market for annuities is now smaller after pension freedom reforms introduced in 2015 led to fewer people taking them out. Now just six companies offer standard annuities compared to nine in 2007, reducing competition between providers6.
What has all this meant? Back in 2007, the average annuity rate was 6.77%. Applied to the larger pot accumulated in the 97-07 period, this would buy £12,193 a year of income.
Those retiring in 2017 would be able to get average annuity rates of 4.75%, which would turn their pension pot into an annual income of £6,607 - some 46% less.
An instructive way to express this fall-off in income is by comparing the ‘replacement rate’ represented by the annuity income from each period. This is the percentage of pre-retirement income that is replaced by income in retirement. In our scenario, those retiring in 2007 would have been able to replace 19.3% of their income. For the 2007-2017 period, this falls to 12.4%.
This all makes grim reading for the 2017 cohort of retirees - is there any reason for optimism?
One potentially positive change in the period since the crisis has been the pension freedoms reforms which have freed many more people to access their pension pot using drawdown instead of an annuity.
With drawdown, you have the option to take a regular income from your pension whilst keeping the rest invested. Money you leave inside your pension could then continue to grow, while you have the freedom to alter investment choices and the level of any income you receive to suit your needs.
This comes with greater risk, but at least provides an alternative to being locked into low paying annuities and gives you greater flexibility over how you manage your income.
For those still with some years to go before they retire, there’s a chance to make more of the time available left to save. Maximising contributions to take advantage of any employer contributions on offer as well as the help available from tax relief makes sense, as does ensuring your pension money is invested to take a level of risk that you’re comfortable with, but that will give you a chance of decent growth.
Please note the Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at http://www.pensionwise.gov.uk/ or over the telephone on 0800 138 3944.
1 Fidelity International, August 2017. Calculations are modelled on someone ten years away from retirement in 2007 and 1997. Both scenarios earn £45,000 with a £50,000 pot of pension savings and contribute an ongoing 12% of their salary to a pension. Both scenarios are invested into a portfolio of shares and bonds (60/40 global equity, global bond. Salaries are uprated using an average from ONS Annual Survey of Hours and Earnings data and their pension contributions were added to their pot and invested. At the end of both periods (2007/2017) pension pots are used to buy an annuity at market rates of the time.
2 Bank of England, August 2017. Inflation annualised 1997 to 2006 and inflation annualized 2007-2016 = 2.7% http://www.bankofengland.co.uk/education/Pages/resources/inflationtools/calculator/default.aspx
3 Moneyfacts Annuity Data, July 2017. Annuities sourced were standard, level and without guarantee. Figure from 2007 took the best quote for a male and female to work out the overall average figure.
4 Investopedia Calculator, August 2017. Figure given is annualised.
5 Investopedia Calculator, August 2017. Figure given is annualised.
6 Moneyfacts Annuity Data accessed July 2017
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Eligibility to invest into a pension and the value of tax savings depends on personal circumstances and all tax rules may change. You will not normally be able to access money held in a pension till the age of 55. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.