Pension schemes set to lose out under £50bn quantitative easingGovernment boost to economy will hit pensioners

10 February 2012

bank of england

The new £50bn quantitative easing (QE) injection offers good news for the economy, but bad news for pension schemes

The new £50bn injection of quantitative easing (QE) announced by the Bank of England this week risks leaving tomorrow's pensioners worse off and companies facing higher pension contributions.

The expansion of the QE scheme brings the total to £275bn. At the same time, Bank of England base rate was held at 0.5%, the same level it has been at since March 2009.

Who is quantitative easing good for?

Under the quantitative easing process, the Bank of England buys assets using new money it has created. These assets usually consist of government bonds, known as gilts, and corporate bonds. The commercial banks and insurance companies selling those assets will then hold more cash, which they will hopefully lend to businesses and individuals, increasing the money supply and providing a boost for the economy.

As the Bank of England buys bonds, it reduces the supply of remaining bonds in the market and pushes up their selling price. As the price of these bonds rises, the yield (or return) on them falls. Take as an example a £100 bond that pays 4% a year of the face value. If the price goes up to £120, the owner still only receives a return of 4% of the £100 face value. This is a return of 3.3% on the £120 market value.

Many interest rates, such as mortgages, are linked to gilt yields, so lower returns on gilts should lead to lower borrowing costs.

Why is quantitative easing bad for pensions?

The drop in bond yields caused by QE has a twofold impact on pensions:

  • Pension funds invest heavily in gilts and commercial bonds. If bond yields fall, the money earned by pension funds will also reduce. To maintain the same level of investment return, employers and employees will need to increase contributions. The problem affects both final salary and money purchase pension schemes. If employers have to pay more into their pension funds, the risk is that they won't invest in job creation schemes or the expansion of their business. Alternatively, they may decide to close their pension schemes or reduce the benefits paid.
  • Reductions in bond yields also cause annuity rates to fall. So when you come to convert your pension fund into a regular income, you'll now need a bigger pension pot to create the same amount of pension income. Again, you'll need to increase pension contributions to make up the shortfall. If you're very close to retirement, however, this may be impossible and you could end up locking into a lower-paying annuity for the rest of your life.

The impact of QE makes it more important than ever to take professional advice before converting your pension fund into a regular income, and to shop around when choosing an annuity provider.

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