Interest rates rise again – what pension planners must consider

Britons are becoming increasingly used to the ripple of economic shockwaves. And no doubt, regular updates about rising inflation and the cost-of-living crisis will be a cause of concern to many.

To counter the skyrocketing cost of goods, the Bank of England (BoE) has set out its stall – ‘interest rates must rise’ has been the mantra of the past nine months. Indeed, on 4 August 2022, the central bank announced its sixth consecutive hike in the base rate, this time by a more significant jump of 0.5%. 

It means that since December last year, interest rates have risen from a record low of 0.1% to the current 1.75%. The economic policy being pursued by the BoE is well established: by increasing rates, they are driving up the cost of borrowing and incentivising saving; in turn, this ought to bring down consumer spending, dampening demand for goods and thereby helping to lower prices.

Its goal, as always, is to keep inflation at no higher than 2%. At present, it resides at 9.4% in the UK, with many experts predicting that it will climb to 11% or above by the end of the year.

There can be no denying that we are living through a very challenging economic climate. In announcing its latest interest rates hike, the BoE warned that the country will enter a recession by late 2022 – this will have done little calm nerves.

Evidently, a careful marshalling of one’s finances, combined with diligent financial planning and management in the short, medium, and long term, is extremely important. So, let’s review how rising interest rates might affect pension planners and outline some of the key questions to consider at this time.

Interest rates and pensions

As a rule, higher interest rates ought to benefit pension pots. It will mean that savings sat in many types of pensions will increase in value more significantly.

But it is not always that simple. 

For one, the returns on some pension pots or investments might not be linked to interest rates. They may instead be reliant on the performance of other assets or markets, such as stocks and shares.

Moreover, increases in the BoE’s base rate are not always reflected in the interest rates offered by different pension providers or indeed banks where their general savings accounts are concerned. Sometimes there can be a delay before updated rates are implemented, or else the terms of the investment might have fixed rates rather than ones that track the base rate, meaning there will not be any changes across a set period of time.

It is worth reviewing your individual pension plan and, as necessary, contacting the provider to get a clearer understanding of how the recent interest rates hikes will affect your retirement finances.

Inflationary concerns

The other critical consideration here is that, while interest rates are rising, there remains a huge gap between the base rate and the rate of inflation. The rising cost of energy and consumer items means that even at the new, higher rates, very few savings or investments can yield returns that can top inflation, which is nearing and soon likely to exceed 10%.

This is why people talk of money ‘losing value in real terms’. As the cost-of-living increases at pace, £1,000 today will not stretch as far in a year’s time – it will buy you less, as a rough rule of thumb.

So, there is no room for complacency. Again, it is vital that people take stock of their current pension plans and retirement finances, assess what rising interest rates and inflation could mean in the longer term, and then consider what changes in strategy might be required.

It is not an undertaking that should be taken alone. These are complex economic conditions, and the landscape is constantly evolving. As such, seeking independent financial advice is key.

The thoughts of our executive chairman

Our executive chairman, Andrew Megson, offered his thoughts on rising interest rates last week (as published in the Daily Express):

“Another interest rates increase – particularly a more significant jump than previous ones – would usually be good news for pension planners, improving the performance of their savings. In reality, any improvements in the interest earned on savings will be dwarfed by inflation, which is only going to rise more steeply in the months to come.

Make no mistake, the current economic climate is very difficult to navigate, and the consequences are far-reaching. Many over-50s are coming out of retirement in their thousands (7% of over-50s in work currently have “unretired” in 2022, according to My Pension Expert’s latest research) due to the cost-of-living crisis. Even more will be worried about their financial futures.

It is so important right now to refrain from making any rash decisions that could later damage a person’s financial security. Where pension planning is concerned, in times of economic uncertainty it’s crucial to first review your retirement strategy. Likewise, a sensible move would be to speak to an independent financial advisor to explore all options available, whether that’s annuities, flexible-access drawdowns, or riskier investments that could offer more favourable returns in the face of inflation. There is no one-size-fits-all solution; it’s about finding the right approach for your circumstances and your needs.”