The Bank of England’s move to cut the UK base rate to 0.25 per cent could have negative ramifications for pensions, providers have warned.
The Bank yesterday (March 11) slashed the UK base rate to 0.25 per cent in a bid to boost economic demand at a time when coronavirus is causing severe economic uncertainty.
But providers have warned this could have negative consequences for pensions with falling gilt yields having the potential to push up the value of defined benefit liabilities and further drive down annuities.
It could also affect those in capped drawdown as this is also based around gilt yields.
Ian Browne, retirement expert at Quilter, said: “[In capped drawdown] the maximum income level is based on 15 year gilt yields. With the drop in base rate, the 15 year gilt yield is likely to drop.
“A drop in 15 year gilt yield means that the next time someone has to review their maximum income this could be lower than they were expecting. That, along with the recent falls in asset values, could limit how much income they withdraw.”
Mr Browne said clients have two options to offset this issue. Firstly, they could choose to keep to the maximum income and therefore not trigger the money purchase annual allowance, or they could exceed the maximum by moving into flexi access drawdown and trigger the MPAA.
He said: “By triggering the MPAA, you limit the amount you can contribute going forward. This is most likely to impact people who are withdrawing an income from their capped drawdown arrangement and still working. These options need to be considered carefully.”
The cut to interest rates will also negatively affect annuity rates, which reached record lows last year.
Mr Browne said: “A fall in the UK base rate could lower long term interest rates which in term could lower annuity rates and so they may be better off waiting to buy an annuity till rates are better if they can.
“The most important thing is to ensure your clients don’t panic. It’s a complicated area and that means it's time for advisers to demonstrate their value.”
Tom Selby, senior analyst at AJ Bell, said: “While the flexibility of drawdown is now the preferred option of most savers, the 70,000 or so people who buy an annuity every year could face a hit to their retirement incomes.”
The rate cut is also bad news for DB schemes as a drop in yields will also push up the value of liabilities.
Mr Selby said: “Given UK DB schemes were in deficit to the tune of almost £125bn at the end of February, a rate cut is arguably the last thing company sponsors need right now.
“If deficits do rise then difficult decisions will need to be made at corporate level about the balance between paying dividends and increasing contributions to fund these yawning pensions black holes.”