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How is Covid-19 impacting long-term pension planning?

Many of us are now focusing on getting through the short to medium-term, rebuilding our finances and relishing a return to everyday life after the Covid-19 pandemic. Consequently, pension contributions and retirement income are not top of the agenda. However, there have been significant reductions in pension contributions which will impact income in retirement. While the real impact may take 20 years or more to emerge, it needs to be addressed now!

Mark Benson
· 14 min read

How is Covid-19 impacting long-term pension planning?: Your questions answered

  • Should I review my retirement plans in light of Covid-19?

    Many people are considering adjusting their retirement plans due to the financial and employment impact of the pandemic. It may be that your finances have performed relatively well, and you are still on track to retire as planned, but you need to review your finances.

  • Will stocks and shares recover across the board?

    This is an impossible question to answer even though we have seen stock markets recover to within just a few percentage points of pre-Covid levels. Moreover, the performance of individual stocks and individual sectors has been varied. As a consequence, a short-term recovery across the board is difficult to predict with any absolute certainty.

  • Can I make better use of my savings?

    It would be best to discuss this with your financial adviser, but there may be potential to make better tax-efficient use of your savings. For example, those approaching retirement might be able to increase contributions and use unused tax allowances from the past. This is based on the tax relief available on pension contributions and how this might impact your long-term retirement income.

When we look back at the Covid-19 pandemic, it is only in years to come that the true impact on personal finances and pension funds will become clear. The long-term effect of reduced contributions, unemployment and weakened personal finances may take many years to emerge, especially with pension funds. Following the publication of a rapid evidence review by the Money and Pensions Service, we’ve looked at how Covid-19 is impacting long-term pension planning and any actions you can take.

Research suggests a changing pension landscape

In tandem with the University of Leeds, a report produced by the Money and Pensions Service has cast a fascinating light on pension planning. There are many issues to consider, with several warning signs starting to emerge.

Reduced contributions

Even though the UK economy is turning a corner, furlough is set to run until the end of September 2021. While the funding available to support wages will taper down as we approach September, many people have been on reduced income for more than a year.

Before we look at this in more detail, the following graph highlights some interesting trends regarding reduced pension contributions as a consequence of Covid-19.

Source: Money and Pensions Service

The above graph shows several trends, including:

Even if the economy was to return to previous activity levels in the short term, there is no guarantee that pension contributions would follow suit. We are still awaiting the real impact of unemployment, reduced savings and increased debt for many people.

Reduced return on pension fund investments

There are various factors to consider when looking at future returns on pension fund investments.

Stock market investments

Firstly, while the pandemic is still ongoing, stock markets have recovered relatively well since the emergence of the virus in February/March 2020. As you will see from the following FTSE 100 graph, the market is down just 6.7% from the start of 2020 and only 8.6% off the all-time high reached in May 2018:

Source: BBC

On a note of caution, it is essential to realise that the performance of individual shares and sectors has varied significantly. We also know that numerous quoted companies have seen their balance sheets weakened, even while in receipt of furlough funding, with many planning the reduction or suspension of short to medium-term dividend payments.

This will have an impact on pension fund investment income. Whether this results in investment switching to high-income assets, which traditionally have reduced potential for capital growth, remains to be seen. Some fund managers or those managing their own portfolios are stuck between a rock and a hard place in many ways. Do they switch to more income-related investments to make up for the short-term reduction in dividend income while sacrificing an element of long-term capital growth?

Long-term capital appreciation

The second main issue revolves around reduced pension contributions in the short to medium term and the impact on long-term capital appreciation. As the first graph shows, those in the 18 to 24 age group have seen the most significant reduction in pension contributions due to Covid-19. This is more relevant than older age groups because, in theory, early pension contributions have upwards of 30 years of potential capital appreciation.

While those in the older age groups also have the potential for capital appreciation on their contributions, this will be over a shorter timescale. It will be interesting to see whether future research shows a return to previous pension contribution levels.

Those near or in retirement

Those aged 50 and above tend to fall between the cracks when considering the impact of Covid-19 and other social and financial earthquakes. There is a general misconception that “they have already planned for retirement", and short to medium-term volatility won’t impact their plans. Unfortunately, this is not the case!

The Money and Pensions Service report highlighted some very worrying trends. We now know that:

Historically, those approaching retirement have increased their pension contributions with one eye on long-term retirement income. However, we are likely to see a reduction in those increasing their pension contributions in the short to medium term and accessing unused allowances from the past. Consequently, there will be an impact on the levels of income available for many people during retirement.

Increase in pension scams

History shows that the number of attempted scams and instances of fraudulent activity tend to soar during times of hardship. Unfortunately, it would appear this trend is continuing in light of the Covid-19 pandemic. The Money and Pensions Service report confirms:

Astonishingly, between February 2020 and October 2020, more than 20% of adults confirmed receiving an unsolicited approach regarding their investments, pensions or retirement planning. A further 22% believe fraudsters may have contacted them. Not surprisingly, this has led to a significant reduction in confidence in managing their finances amongst those approaching retirement:

46% of adults aged between 45 and 54 say they now lack confidence in managing their finances, compared to 38% across all age groups

Two factors need to be addressed to restore confidence amongst those approaching and those in retirement. First, specialist financial advice needs to be more readily available for those approaching retirement. Second, further education on the consequences of recent pension regulation changes is also required. While the relatively recent changes offer a more flexible approach to pension income and management in the future, this has in some ways left the door ajar for fraudsters and scammers.

The ongoing creation of a Pensions Dashboard by the UK government and supporting third parties is undoubtedly a move in the right direction. However, an appropriate level of support must be available for those less confident in managing their finances.

Short-term financial hit ahead of retirement

As we have mentioned on numerous occasions, the long-term nature of pension savings and the potential for capital appreciation is central to successful retirement planning. Indeed, long-term investment has been shown to reduce the impact of market volatility on long-term returns. However, this leaves a much shorter timescale when approaching retirement to try and make up for any significant financial hit.

The challenges faced include:

Switching investment strategies when approaching retirement

Typically, there is more focus on investments offering long-term capital appreciation in the early years of your pension than short-term income. The degree of emphasis on investments offering capital appreciation will vary from person to person, dependent on their investment strategy. This is where the situation becomes more challenging. The traditional route to retirement involves a switch from capital appreciation to stocks providing increased income. While creating a more secure income stream for retirement, this strategy reduces the opportunity to make up for the short-term shortfall by capital appreciation.

Even though the UK stock market as a whole, and worldwide financial markets, have recovered much of the losses incurred in the early days of Covid, overall performance is still mixed. Many of the high-tech potential high growth stocks of yesteryear are struggling with an uncertain outlook and weakened balance sheets. On the other hand, those offering an above-average secure dividend have fared better on the whole. So, the timing for a switch from capital appreciation to income generation could not have been worse for those approaching retirement.

Uncertainty over dividend income

While it seems highly likely that the UK is well on the way to recovery, recent events suggest this will not be plain sailing. The emergence of various Covid variants has created concern about lifting restrictions and returning to "normality". Moreover, there is uncertainty over short to medium-term dividend policies for those looking to switch from more capital appreciative investments to those based on income.

Sectors such as banking are likely to return to more proactive dividend policies in the short term, but nothing is guaranteed. Consequently, shifting from investments offering capital appreciation, with limited income, to those more focused on income is something to consider carefully in the current environment.

How can you reduce the impact of Covid-19 on your pension assets?

While can be difficult to see the light at the end of the tunnel, there are actions you can take which will at least mitigate the short-term impact of Covid-19 on your pension funds. But, unfortunately, there is no silver bullet or a quick way to fix the effect on pension assets, and for many, it will involve a change to their long-term pension plans.

Postpone retirement

Whether you are planning to retire in your 50s, 60s, or later, the thought of postponing your retirement is heart-breaking. It may be that a short-term delay in your retirement will allow your investments to recover, resulting in increased income in later years. You may need to revisit your original pension/retirement plan and recalculate figures on reduced returns.

Employment

As we touched on above, many people planning retirement in the short term have now switched their thoughts towards short to medium term employment opportunities. This has the potential triple whammy of giving your pension investments time to recover, creating additional income to cover living expenses and the opportunity to fund future pension contributions.

Additional pension contributions

Many of those approaching retirement today will have benefited from the considerable increase in property values over the last 40 or 50 years. Those looking to downsize their properties may release additional capital, which could be used to top up pension contributions. While there is a degree of risk when investing pension funds, pension contributions will usually attract tax relief. Depending on your scenario, this could be a tax-efficient use of savings or funds not required in the short term.

Tweaking your short-term retirement plans

Unfortunately, there is no doubt many people have seen their finances, including their pension assets, impacted by the Covid-19 pandemic. Reduced income for those on furlough, job losses and high debts have placed pension contributions well down the list of essentials. Thankfully, there are several ways in which you can look to benefit from the eventual recovery in the economy and growth in stock markets.

Whether looking to tweak your retirement date, seek short-term employment or make tax-efficient use of your savings, these are all options to consider. It would help if you spoke with your financial adviser, taking a look at your broader financial picture instead of focusing wholly on your pension assets and retirement plans.

Mark Benson

Mark Benson

Mark has over 10 years’ experience specialising in writing around property, finance, and investment subjects. Mark has been published on a variety of popular websites covering these topics and others.
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