The Impact Of Interest Rate Rises On Pensions

Many commentators believe one short statement (“some withdrawal of monetary stimulus is likely to be appropriate over the coming months”) from the minutes of the latest Bank of England Monetary Policy Committee suggest an interest rate rise is likely before the end of 2017. In this post, we discuss the potential impact of a rate rise on pensions.

Any initial movement in interest rates is likely to be small (probably 0.25%), it is the signal any interest rate rise sends to the markets and the longer term trend that is more important. A one-off rise will most likely cause little more than an initial blip but a trend of one rate rise, swiftly followed by another, then another may have a more lasting impact.

Pension Holders With Many Years To Retirement

For those pension holders fifteen years or more from retirement, the short term impact of any interest rate changes is of little interest what matters is long term growth, primarily driven by the performance of the stocks and shares element of their pension portfolio. In general, modest increases in interest rates and inflation are positive for those with many years to go until retirement.

Pension Holders Near To Retirement

For those in defined contribution (money purchase) type schemes, the choice to be made when nearing retirement is between flexi-pension drawdown or an annuity. If considering entering pension drawdown the challenge is to evaluate what impact ongoing interest rate rises may have on the value of an investment portfolio.  It is also important to assess the impact of interest rate rises on inflation over the medium to long term.

A number of factors have driven Annuity rates down over recent years making drawdown a more attractive choice. However, interest rate increases tend to force up Annuity rates. Given, the long term security offered by an Annuity increases in their value can make them a more attractive proposition.

For members of a defined benefit pension scheme an interest rate rise can increase the long term security of their pension scheme. Many defined benefit pension schemes are in significant deficit as a result of long term low interest rates and successive rounds of quantitative easing. Even a small increase in interest rates can have a significant positive impact on pension deficits.

Interest rates do not impact on the value of the final salary pension payable at retirement, the only potential worry is inflation although many final salary pensions are index linked to cover moderate inflation year on year.

The only major consideration therefore for final salary pension holders is the pension transfer option. A number of factors, including long term low interest rates and significant pension deficits have driven transfer values on many schemes to an all time high in 2017. This had led some to seriously consider the transfer option. Even a small increase in interest rate could drive transfer values down significantly from their current high towards the long term average.

For Those In Retirement

It is probable those in retirement either with an Annuity or in drawdown will have some savings in cash, cash ISA or stock and shares ISA. Ongoing interest rate increases should increase the interest on these accounts.

The major enemy of those in retirement is inflation and, in principle, increasing interest rates should control the rate of increase in inflation. However, it is important to note there is no direct relationship between interest rates and inflation as it depends, to an extent on what factors are driving the inflation.

Should you have any concerns relating to your pension please do not hesitate to give us a call on 0800 043 8341 or email and we will be happy to help.

The purpose of this article is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances.