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.
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:
- More men than women have reduced their pension fund contributions.
- More women than men have stopped their pension contributions altogether.
- Pension contribution reductions are highest in the age group 18 to 24.
- The highest increase in those stopping pension contributions entirely was seen among over 55s.
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:
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:
- 13% of workers have changed their retirement plans because of Covid-19.
- Of those, 8% are planning to retire later, 5% retire earlier, with just over 30% confirming they have been impacted financially by the pandemic.
- 58% of those who retired between March and October 2020 did so as a consequence of Covid-19.
- Nearly 25% of this group did so because they lost their job or were unable to find work.
- Those aged 65 and over were the second hardest-hit age group by Covid-19, just behind the under 25s.
- Over 50s now account for 24% of unemployment.
- Of this group, 33% have been unemployed for at least a year and 20% for at least two years.
- This compares to 20% unemployment for at least one year and 8% for at least two years, in the under 50s age group.
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:
- 253 police investigations into pension fraud in 2017.
- Increasing to 394 in 2019.
- A further 545 ongoing investigations in 2020.
- Between the start of the pandemic and late June 2020, the National Fraud Intelligence. Bureau received more than 2000 reports of Covid-19 related fraud.
- Alleged pension fraud reported in 2020 totalled £7 million.
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.
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.
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.