Brexit: what a leave vote could mean for your retirement income
Given the very high levels of uncertainty around the long-term economic consequences of a leave vote, it is probably ambitious to attempt a forecast of eventual outcomes.
However we do anticipate a period of market instability and volatility in the event of a leave vote, which could have a short-term impact on UK pensions. For investors faced with making short-term decisions therefore, the consequences could be good or bad, depending on your circumstances. For longer term investors, there is probably nothing to be gained by acting in haste.
Below we explore some of the possible consequences of a leave vote:
A leave vote is likely to lead to a period of short-term market turbulence. We could see a fall in sterling (this appears to be priced in to a limited extent already), and a rise in gilt yields. A case can be made for either a rise in bank base rate, in response to a fall in the pound, or indeed further Quantitative Easing in response to a slowing economy.
Rising gilt and bond yields, especially if accompanied by higher short-term interest rates, would feed through into higher annuity rates. This is because the insurance companies selling annuities would be able to generate a higher income from the underlying investments into which they invest annuitants’ capital.
Pension fund assets
The short-term consequences of a leave vote are almost certainly going to involve some market volatility and a fall in asset prices would certainly not come as a surprise. For any investor approaching retirement therefore, any possible gains from an increase in annuity rates could very well be offset by a drop in investment fund values.
Final salary scheme deficits
The same dynamics could apply to final salary pension schemes. On the one hand a rise in gilt yields could lead to reduction in schemes’ liabilities, however they may also find any gains being offset by falling values of scheme assets.
In terms of higher inflation, some final salary pensions and many individual annuities do not have full inflation-proofing. Higher inflation could therefore undermine the real value of these incomes. However we also note that a rise in bond yields following a leave vote could equally have a significantly beneficial impact on final salary scheme deficits.
Higher inflation could negate the above inflationary increases enjoyed from State Pension recipients, thanks to the 2.5% increase element of the triple lock (an increase in State Pension by the higher of earnings growth, inflation and 2.5%).
For as long as earnings and inflation are below 2.5% therefore, this is the prevailing increase mechanism and the State Pension increases by 2.5%, meaning it is moving up faster than the rest of the economy, as measured by earnings and inflation.
However it is important to note that pensioners would still be receiving increases pegged to inflation and so would maintain their standard of living, they just wouldn’t be moving ahead of inflation and the rest of the population quite so quickly.
Tom McPhail is head of retirement policy at Hargreaves Lansdown