Unfortunately, there looks to be no imminent let up to the cost of living pressures being faced in the UK.
Inflation is proving to be much less transitory than the Bank of England originally forecast, and rather than peaking at around the current 4.50% there is a growing market expectation that base rate could end up being closer to 6.00%.
We are seeing some of the recent price rises being locked in by an inflationary wage/price spiral; recent ONS data has shown annual regular wage increases (which exclude bonuses) of over 7%, higher wages and costs lead companies to raise prices, rising prices push staff to look for higher wages, and round and round the circle we go.
The impact of these rate rises is still to fully feed into the housing market; there are expected to be around 4.4m mortgages renew between now and 2024. With many of these having been fixed with interest rates below 2%, the current rates are going to lead to significant cost increases for many households.
So, how does this impact defined benefit pensions? To take each point in turn:
- There had been an expectation that ‘transitory’ inflation would mean interest rates fell almost as quickly as they rose. This is now less certain, and we are seeing interest rates remaining at these high levels for longer being priced into yield curves. All other things being equal, this will mean CETVs stay at current levels – down around 40% from their peak in 2022 – for longer.
- Higher household costs look like they are here to stay. As companies increase wages, they are permanently increasing the cost of providing goods and services. This can have a significant impact on those who have built retirement plans on assumed future costs, and now find that they need a greater budget to match their expected living standard.
- We are going to see millions of households faced with significantly higher mortgage costs. There will undoubtedly be cases where people look to take any measure to reduce the cost of unaffordable debt. This could include taking tax free cash while they are still working, or even cashing in a pension. While those approaching or in retirement are less likely to have a mortgage, they may well want to help children who are struggling and look toward the Bank of Mum & Dad for help.
Advice is arguably the most challenging when any decision a customer makes requires trade offs to find the ‘least worst’ solution. For example, a client could take a greater income from their pension to cover their costs, but risk running out of money and suffering poverty in later life. Or, you can cash in pensions to clear an unaffordable mortgage, but then leave yourself without sufficient provision for retirement.
There is often a ‘present day’ bias; people want to solve the immediate issue today, and also pretty much everyone will be more emotionally attached to their home, or helping their children, than they are to their pension.
Emotional, heat-of-the-moment decisions could lead to long term consequences that need to be understood and thought through. Where these type of trade offs are brought into play, the need to have a cool head and clear, professional advice is essential.