UK - Pension time bomb' warning: Annuity rates slashed 8% and final salary deficits widen as Brexit vote sees gilt yields crash?
A collapse in gilt yields - the interest earned on UK Government bonds - could be building a 'pension time bomb' as annuity rates are slashed 8 per cent and final salary scheme deficits widen after the Brexit vote.
Both annuities and final salary pensions, which provide retirees with a guaranteed income for life, are underpinned by gilt yields which have plummeted to unprecedented lows below 1 per cent in the days since the EU referendum.
Personally I believe that this is without doubt the toughest period annuities have had to endure and right now we are building up a pension time bomb.
Gilts are also routinely held in income drawdown portfolios, as a form of ballast while other pension savings are invested in riskier assets like stocks.
Scaremongering predictions about the future of pensions and other retirement benefits after a Brexit vote were proclaimed during the EU campaign, and naturally decried by the leave camp.
But whatever the tosh talked in the heat of a referendum battle, there are bound to be consequences for savers approaching retirement and pensioners now the UK has broken with Europe - on investment returns, interest rates, expat arrangements, and future rises in the state pension.
It's also likely an overhaul of pension tax relief that could see savings incentives slashed will be back on the table, especially if public finances come under pressure.
This is how events might affect older savers after the shock EU referendum result.
What next? Government might try to argue largesse to pensioners is unsustainable if a big black hole opens in the UK's finances after a Brexit vote.
Below are my views on what could be affected in near future:
1) Pensioner benefits: Would politicians risk enraging pensioners by axing triple lock?
Guaranteed rises in the state pension under the 'triple lock' could be threatened if Brexit caused an economic meltdown, according to statements by the remain side in recent weeks.
The 'triple lock' means that state pension payouts always increase by whatever is the highest of inflation, average earnings or 2.5 per cent. This totemic policy heads the list of pensioner benefits - free TV licences, bus passes, the winter fuel allowance - that the Tories have gone to great lengths to protect despite swingeing spending cuts in many other areas over the past six years.
The implication is that all this largesse might prove unsustainable if a big black hole opens in the UK's finances after a Brexit vote.
How likely is Prime Minister David Cameron's successor to actually wield the axe? While there might be pressure on public finances, perhaps temporarily, in the aftermath of Brexit, no one knows for sure how serious this will be or how drastic a response would be required.
But what everyone does know is that politicians of all parties are keen to retain pensioner benefits, for one simple reason: older people vote.
You can never say never of course, but ditching a popular policy like the triple lock seems like a last resort for any politician hoping to win support from an important voter bloc like pensioners.
2) Investment returns: Turmoil likely until trading terms emerge
Markets have suffered turmoil for months in the run-up to the referendum, and after the Brexit vote such volatility is likely to continue until there is some certainty about how the UK will trade and deal with its ex-EU partners.
Any big losses will affect people saving for retirement in defined contribution schemes, where they bear all the investment risk themselves, and those that have remained invested in income drawdown schemes in retirement.
For younger people, the situation is not grave as they could have the opportunity to buy stocks on the cheap, and they have more time to make up lost ground later. For older people, a financial market shock would be far more significant.
People using income drawdown to fund old age could find their savings demolished, especially if this occurs during the crucial early years because it is then much harder to rebuild a portfolio to a position of strength.
Tom McPhail, head of retirement policy at Hargreaves Lansdown, said regarding future investment returns: 'The Treasury forecasts that productivity in the economy as a whole and household incomes would be lower by 2030.
'Based on these assumption it is reasonable to project that pension fund sizes would be lower, due to lower contribution rates and poorer investment returns.
'In the event that the Treasury forecasts prove inaccurate and that following a Leave vote, inflation does not rise and economic growth does not suffer, then future pension incomes would be no lower than under a Remain scenario.'
Mallowstreet, a finance industry group, surveyed pension professionals at the end of May about how they thought a Brexit vote would affect their scheme's investment portfolio. More than half expected a 'quite negative' impact - a loss of up to 10 per cent. See the further results below.
Survey result: How do you think that Brexit will affect your pension scheme's investment portfolio? (Source: mallowstreet)
The group also asked respondents to highlight their top three investment concerns. Market volatility topped the list at 26 per cent, second was political uncertainty at 21 per cent, third was currency volatility at 18 per cent, fourth was long-term lower growth at 16 per cent, fifth was a UK recession at 15 per cent and sixth was loss of access to investment talent at 4 per cent.
3) Interest rates: Knock-on impact on pensions
It's tricky to call what the Bank of England will do about interest rates. Understandably, it's keeping contingency plans secret to avoid tipping off markets.
The Bank might cut the base rate from 0.5 per cent to 0.25 per cent and launch more quantitative easing if it needs to prop up the economy, or it could hike rates if a run on the pound causes a nasty dose of inflation.ESTORS
Bond 'yields' are a measure of the annual return to investors who buy government or corporate debt. Bond 'prices' are the cost, or what these investors pay to buy the debt.
Bond yields and their prices move in opposite directions. When yields move up, prices fall.
But yields on both government and corporate bonds have been at very low levels for years - meaning they have rarely been so expensive.
In this unusual market environment, uncertainty over when interest rates will rise has become a conundrum for bond investors.
They like the income bonds pay out but are wary their prices will fall once central banks start to hike the cost of borrowing again.
A shift higher in interest rates should send bond yields up. This makes new higher interest rate bonds look more attractive and older lower interest rate bonds less attractive, driving down their price.
Interest rates affect pensions because expectations about them can move stock markets, and because of their impact on government and corporate bonds. Government bonds - UK ones are called gilts - underpin annuities and final salary pensions.
Many investing experts are already worried about a bond crash because the market is skewed by years of heavy purchases by central banks using newly-printed money.
Once central banks start to normalise policy and raise interest rates again, many investors could decide they overbought bonds and dump them in a hurry (see the box on the right). So how does Brexit enter the mix when it comes to bonds?
McPhail said: 'A leave vote is likely to lead to a period of short-term market turbulence. We could see a fall in sterling 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.'
Tom Stevenson, investment director for personal investing at Fidelity International, said government bonds have benefited from heightened uncertainty of late.
'Investors have seen gilts, [German] bunds and US treasuries as safe havens, pushing their prices higher and their yields (which move in the opposite direction) down to scarcely believable levels.
'I would not be surprised if bonds remain in favour after the referendum. A leave vote might place a question mark over the willingness of overseas investors to continue investing in UK assets but this would be offset by bonds’ port in a storm characteristics.
4) Expats and frozen pensions: Common sense will probably prevail
Older people who have emigrated elsewhere face a troubling period after the Brexit vote. For those who have moved to other EU countries, it will take some time to renegotiate their status and hammer out new arrangements for paying pensions, access to social services and so on.
Expats living anywhere will be affected if the pound doesn't recover its immediate losses, because any income they receive from the UK will lose value. However, if Brexit is perceived to be as negative or even more so for the EU as for the UK, then the pound might not move as much or might even appreciate against the single currency.
The worst case scenario is probably that many expats would return to the UK against their own wishes - either under their own steam for financial reasons, or because they were ousted from other EU countries should no deal be struck allowing them to stay.
Common sense suggests the latter is only a remote possibility, but no one knows. No country has ever left the EU before, and great bitterness could accompany the break-up. The EU might force the UK to continue to allow free movement of people - a contentious issue in the EU debate - as a condition of allowing its expats to remain in places like Spain.
Meanwhile, expats in the rest of the EU might be able to stay but find their state pensions are frozen in future.
More than half of the one million pensioners living abroad don't receive annual increases in their state payouts - meaning someone who retired when the basic rate was ￡67.50 a week in 2000 would still get that, rather than the ￡119 received by everyone else now.
Whether an expat's pension is frozen or not depends entirely on where they move to, because the Government has struck individual deals with some countries but left around 150 others out in the cold.
This means people retiring to Canada, Australia, India, Africa and many parts of the Caribbean lose out on state pension increases, while those living in EU countries, the US, Jamaica, Israel and the Philippines get their full whack.
Years of campaigning by people with frozen pensions have not secured any compromise with the Government over this issue. See the map and the full list of countries where pensions are frozen below.
Currency specialist HiFX estimates that more than one million UK pensioners overseas could face a potential loss of ￡944million a year from Britain leaving the EU. This is based on Government data showing annual pensions paid to 1.1million retires living abroad total ￡6,298,600,000, and a potential 15 per cent depreciation in sterling.
Where are pensions frozen? More than half of the one million pensioners living abroad don't receive annual increases in their state payouts
5) Pension tax relief: Threat remains real whatever the outcome
Chancellor George Osborne is believed to have held off on a plan to axe pension tax relief and introduce a Pension Isa for everyone in his March Budget, for fear of a backlash from voters ahead of the Brexit referendum.
Instead he launched the Lifetime Isa, which will allow people aged 18-40 to save for a home and retirement at once from next Spring. This was widely seen in the finance industry as a prototype or 'Trojan horse' for a full-blown Pension Isa, which could be dusted off if the Government wins the EU vote.
Introducing a Pension Isa would mean savers no longer receive tax relief on contributions to a pension, at a cost of ￡34billion-plus a year to the Treasury. Instead it would pay out tax free in retirement, providing a future Government didn't slap penalties back on later.
The other option understood to be on the table before the Budget was a new flat rate of tax relief on contributions of between 25 per cent and 33 per cent. This would mean all taxpayers received the same level of tax relief regardless of how much they earned.
Next Prime Minister? David Cameron's successor might be tempted to raid pension tax relief too.
Either plan would abolish for good the historical principle that the money people put towards old age saving is not taxed no matter how much they earn - an idea that originated in the Finance Act of 1921. Wealthy savers already face curbs, so it's no longer a hard and fast rule anyway.
Tom Selby, senior analyst at investment broker AJ Bell, noted: 'A post Brexit vote emergency budget that increases income tax would immediately increase the cost of pension tax relief to the Government at a time when the Chancellor claims they would be making cuts in other public spending areas.
'The mounting Treasury bill for pension tax relief has been a concern for some time. However, a combination of the EU referendum and the complexity associated with a fundamental overhaul saw the Chancellor put reform on ice at the last Budget.
'Any further increase in the cost of pension tax relief will be looked at very closely and this raises the question again as to whether pension tax relief would be put back on the chopping block in an emergency budget.'
Whether Osborne resurrects his earlier plans will probably depend on political machinations after the referendum, which I believe we will see play out over coming weeks.
Cameron has already announced his intention to resign, and Osborne might not be Chancellor for much longer.
Should any successors still try axe pension tax relief as a money saving exercise, a backbench revolt by disgruntled Tory MPs could scupper it, given the party only has a small majority.
Current Pensions Minister Baroness Altmann said 'turning pensions into Isas would be a disaster' at a meeting of industry insiders in April - potentially setting her at loggerheads with the Treasury should it revive the radical idea in future, and should she survive a Government reshuffe.
However, given that pension tax relief costs billions of pounds a year, a new Tory prime minister or a future Labour Government might very well be tempted to raid pension tax relief to get their hands on that money.