The Covid-19 pandemic has impacted pension savers in both positive and negative ways, with some able to benefit from the effects of lockdown, while others have endured a sharp financial hit, says AJ Bell senior analyst Tom Selby.
While just over a fifth (22%) of the population were financially worse off, one in seven (14%) said the events of the year had helped to boost their finances. As a result, the savings ratio surged to a record 29%.
Impact on pension contributions
The sharp unemployment levels seen as a result of the pandemic have had a detrimental impact on pension saving, with those made redundant missing out on matched employer pension contributions and pension tax relief, says Selby.
He explains: “Take someone earning the UK average salary of £30,000 a year who had previously been auto-enrolled at 8% of band earnings and lost their job or chose to opt-out at the end of March.
“Assuming they remained unemployed throughout 2020, they would miss out on £534.60 in matched employer contributions. Assuming they had not set up an alternative pension arrangement, they would also not receive £178.20 in pension tax relief on £712.80 in personal contributions.
“All-in, the lockdown hit to an average earner’s workplace pension could be over £1,400, including over £700 of ‘free money’ from employer contributions and upfront tax relief.”
In contrast, pension savers who “drip fed” their pension contributions throughout the Covid-19 pandemic will have benefitted from automatic smoothing through ‘pound cost averaging’, says Selby.
By saving and investing little amounts each month, rather than one big lump sum, savers can reduce market timing risk.
According to Selby, someone who invested £1,000 a month from 31st December 2019 would have a fund worth £12,231 at the end of November 2020, meaning their fund would have grown in value by 2%. In contrast, had they chosen to invest £12,000 as a lump sum on 31st December, their fund would have fallen 14% to £10,277.
People approaching retirement
For those approaching retirement the impact of this year’s market volatility will depend on the investments they hold and how they plan to draw an income, says Selby.
This year marked the first ‘bear market’ – where share prices fall by more than 20% – since the pension freedoms were introduced in 2015.
Selby warns that while those planning to take a regular income while staying invested should have been able to ride out the dramatic market falls seen during March and April, the same would not be true for those planning to buy an annuity.
He explains: “Someone who took a 20% hit to their fund in March who planned to retire in April would be forced to either take a 20% lower retirement income for life or delay retirement and hope their fund recovers. This is why the performance of funds tailored specifically for those planning to buy an annuity was concerning during 2020 Rather than investing in cash, these funds hold things like gilts and corporate bonds which are deemed to be ‘safe’.
“The experience of 2020 has proven they are anything but, and while their value has bounced back the funds have provided a painful lesson in the importance of understanding what you are invested in.”
Taking a retirement income
Pension investors already taking an income have faced a double-whammy this year in the form of deep market volatility as well as widespread dividend cuts – the lifeblood of most retirement income strategies.
Selby says the biggest danger facing those pension investors is ‘pound cost ravaging,’ where poor investment performance in the first few years of retirement can deplete the fund earlier than expected.
However, Selby says the majority of people acted sensibly to the sharp moves in the market. Figures showed that £2.3 billion was withdrawn flexibly from pensions between April and July, down 17% compared to the second quarter of 2019, suggesting many people chose to either pause access or reduce their income as markets plummeted.
The average amount withdrawn per person during the second quarter of this year also fell 18% year-on-year to £6,700.
The defined benefit market remains uncertain
Defined benefit schemes have also endured significant volatility this year. The Pension Protection Fund issued an update on the latest defined benefit funding data showing a £40 billion drop in aggregate deficits of UK schemes in October to £126 billion. However, Selby warned that the figures were not a reflection of an “overnight strengthening” of the funding position of schemes but a result of more up to date information, including the removal of a number of poorly funded schemes.
While the positive Coronavirus vaccine news in November has benefitted DB schemes along with soaring stock markets and higher gilt yields, sponsoring companies continue to face deep uncertainty.
Selby adds: “These remain difficult times both for pension schemes and many of the companies sponsoring them. We have already seen Arcadia go to the wall in recent weeks and the pressure facing firms most affected by the pandemic will likely continue over the winter months.
“Members worried about the future should at least take comfort from the fact that the PPF exists as a valuable lifeboat, paying out at least 90% of the value of their benefits should their employer go bust.”
