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What does another interest rates hike mean for retirement planners?

Yesterday, for the tenth consecutive meeting, the Bank of England (BoE) decided to raise interest rates to 4%. 

The 0.5% hike to the base rate came as no great surprise. Over the last year or so, Britons have become accustomed to announcements of rising interest and sky-high inflation rates. After all, the two are closely linked. 

That said, the regularity of these economic updates is still likely to fuel a degree of anxiety within millions of households, with individuals and businesses continuing to feel the squeeze on their finances. Indeed, for those planning for retirement, the current climate presents some unique challenges. 

To better understand why the base rate continues to rise, let us first recap how interest rates have changed over the last decade. 

  • Following the global financial crash in 2008, the BoE cut interest rates to record lows in an effort to support the economy. Throughout most of the 2010s, the base rate sat between 0.25% and 0.5%, before increasing to 0.75% in August 2018. 
  • While these low rates were particularly beneficial to homebuyers, they were detrimental to savings returns. Accordingly, when the ‘pensions freedoms’ were introduced in 2015, millions opted for more flexible pension options not linked to interest rates. 
  • Then came the Covid-19 pandemic in 2020. The BoE reduced interest rates to a historic low of 0.1%. In 2021, inflation rose, and the cost-of-living crisis began to take shape, causing the Bank to increase the base rate for the first time in three years. 
  • The following year, the war in Ukraine, high energy prices, and soaring inflation led to consecutive increases right up to the most recent hike. 

Inflation eased slightly in December, falling from 10.7% to 10.5%; however, until there is a significant drop, the BoE will likely continue to increase rates well into 2023, given it targets an inflation level of no more than 2%. 

What does this mean for pension planners?

In general, higher interest rates benefit savings accounts and some pensions by increasing the interest earned. However, pension planners should be aware that not all pensions are tied to interest rates. Many investments do not directly relate to interest rates – their performance is instead based on the fluctuations of other assets or markets, such as stocks and shares.

Further, as we noted when we last wrote on this subject last year, the BoE’s base rate is not always immediately reflected in the interest rates offered by different pension providers, or indeed banks. 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.

Good for annuities

An annuity is a financial product that someone can purchase with part, or all, of their pension and receive a regular guaranteed income for the rest of their life, or a specified period.

With the cost-of-living crisis and high inflation eroding away the real-term value of people’s pension pots, it is understandable some retirees would seek security in the form of a guaranteed fixed income. However, there is now the added incentive of more favourable returns due to a 12-year high in annuity rates.

Annuity providers generate returns by buying government bonds, which are, in turn, affected by interest rates. When interest rates are low, annuity rates are pushed down. As previously mentioned, during record-low interest rates, the financial benefits of pensions tied to interest were significantly cut. 

Even so, annuities are not suitable for everyone. Their inflexible nature means that once locked in, an individual’s income will not be impacted by any positive market movement or further increased rates.

Read more in our previous blog on annuity rates.

Seek advice

The effect that rising interest rates have on a person’s retirement plan, will depend on their individual circumstances – how much they have saved and invested, and where, not to mention how much debt they have, such as mortgages. 

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 soaring costs of household bills mean that even at the new, higher rates, very few savings or investments can yield returns that can top inflation.

As such, before making a decision regarding any retirement options and to better understand how interest rates and the wider economy will affect their finances and retirement plan, savers should seek independent financial advice. 

Qualified advisers, such as our team at My Pension Expert, can assess a person’s individual circumstances and financial position and provide them with personalised recommendations to help them find the financial products best suited to achieving their desired retirement outcome. Despite economic uncertainty, with the right advice, consumers can feel empowered, knowing they have all the information they need to make the most informed decision possible.