The Many Risks To Your Retirement Plans

This is the second part in a series on saving for retirement that will conclude in some positive steps you can take to defend against future shocks to your retirement plans.

In part one of this series, Why We Have No Confidence In Pensions, I wrote about a selection of failures that have damaged our retirement plans.

In this, the second part in the series, I'll consider what could mess up our plans in the future, and I'll speculate on the likelihood of these things happening. In the third and final part I'll make some recommendations to protect yourself from future failings that won't cost you every spare penny you earn!

Potentially, a lot could go wrong over the next 20 or 40 years, as we move towards our retirements. World Wars 3, 4 and 5. Another Ice Age. An alien invasion. However, I'll try to focus on just a few of the possibilities that are a little more realistic and little less science fiction.

Without further ado, what could go wrong?

Bond rates could get even worse

This one could take a whole article in itself to explain, but I'll trim it down to the essentials...

To a large extent, annuity* rates follow the movement of bond yields, particularly the 10-year gilt. Bond prices are strongly influenced by moves in the Bank of England Base Rate.

Currently, the Base Rate and bond yields are extraordinarily low. However, annuity rates are still around 6-7%, which is high enough for most of us, with sensible planning and enough time, to get a reasonable retirement income. As the Base Rate can only sink to 0%, I suggest that we'd be unlucky if the top annuity rates dropped below about, let's say, 5%, as a result of lower bond yields.

That is still a significant fall which could reduce the income you were expecting to get by 30%. The good news is that such low rates shouldn't last long, if and when they do come about. It's only people who choose to buy annuities at exactly the wrong time who'll be affected.

We could live longer

Living longer comes at a cost. Our increasing life expectancies also reduce annuity rates, because our retirement pots need to be stretched out for longer.

Thing is, if we start living much longer, we simply must retire later, on average. That's the real world speaking. If we work later we'll maintain our annuity rates. Therefore, I'm not going to worry so much about this risk, because it's more about mental adjustment than financial planning.

Inadequate protection when funds collapse

This isn't my greatest concern. The schemes now in place to protect people when their defined-benefit pension schemes* collapse are much better than they were just a few years ago. You won't get your whole pension back, but the compensation should be just about adequate enough.

What's more, this risk gradually applies to fewer of us as we switch from defined-benefit schemes to invest directly into funds. Our money in these funds is sheltered from the collapse of the fund provider, and is therefore very safe. This applies in most cases, whether you are investing in a pension, an ISA, or outside either of these.

Your annuity provider collapses

If you give your retirement savings to an annuity provider in return for an annuity, and the provider goes bust, you are entitled to compensation of approximately 90% of the value of the annuity through the Financial Services Compensation Scheme. Your losses would be significant, but it's also a reasonable level of protection.

It will be a rare event if an annuity provider collapses, because it's all too easy for them to make money due to the pitiful annuity rates they pay us. Annuity providers are also insurance companies, and it's rare for insurers to go bust. (It's too easy to make money as an insurer, too.) Finally, another insurer might decide to purchase a struggling insurer before disaster strikes, which would mean the buyer would pay your annuity for you.

Tax changes

The simplest change to taxes that would adversely affect millions of pensioners would be a hike in basic-rate income tax, but a tax change could easily arrive more stealthily than that. On the other hand, a complete abolition of tax relief on pensions is unlikely, as it would be political (and perhaps actual) suicide to tell people they must pay taxes twice on the same income.

Income taxes are likely to be both hiked and reduced over the next 40 years, affecting each of us in different ways.

A 5% increase in the amount of tax a basic-rate payer pays (whether it's a direct or stealthy increase), would probably have a significant adverse impact on a pensioner's finances. A 10% rise some time in the next 40 years is certainly not unfeasible either, although it's unlikely to be all at once. Many people would have time to modify their plans.

I believe that wealthy lobbyists and increasing globalisation will keep a downward pressure on taxes. This means that, whilst hikes might be significant, they should be manageable.

Basic state pension becomes more basic

The state-second pension might be de-linked from earnings. Again. (Read part one.) Perhaps wealthier people will even lose their entitlement to a state pension.

These are risks, certainly, but the latter is unlikely, as it would infuriate millions to pay National Insurance for years only to lose one of the key benefits. What may happen instead is the package of state pension, credits and benefits rises more slowly or diminishes, but it can't get much lower before people die in huge numbers from the cold or starvation. I trust we won't let that happen!

Again, it could be a significant risk to our incomes if we rely on the state, but it should be manageable if we plan correctly.

Your investments could collapse just before you wanted to retire

Many people's retirement pots crumbled last year, with the stock market down 30%. It'll take years to recover. What's more, falling markets will happen several times over the next 40 years, and so all investors are at risk.

This is a serious concern, but one you can plan for without necessarily putting extra money into your pot.

Let's improve the suspension

The path we walk on towards retirement clearly isn't stable, particularly if we're using pensions (private or state). The list of possible tremors is endless: a reduction in the tax-free lump sum, a reduction in the personal allowance, gas prices rocketing even more, your funds not performing as well as you'd hoped, and so on.

Anything could happen that whacks our retirement pots on the head. Armageddon or, more likely, costly Government tinkering. We can't plan for everything but, for many of the things we can plan for, I'll give you tips in part three: Shock Proofing Your Retirement Plans.

My list above is obviously not exhaustive and many of the figures are guesses (no one knows the future). This is not a white paper, but more something to get people thinking about the sorts of risks we may face in future. Feel free to write your fears (and best guesses) in the comments below.

*Read part one for a description of this term.