The Bank of England is damaging your pension

We've turned to printing more money once again to help combat our economic woes, but our pension pots may pay the price.

All aboard the QE2. Yes, Bank of England Governor Mervyn King and his chums on the Monetary Policy Committee (MPC) have announced a second round of quantitative easing (QE). £75 billion will be pumped straight into the economy in an attempt to stimulate growth and poke our stagnant economy back into life.

But there’s one unintended consequence of this latest move that could hit you big...

Gilt-y pleasure

At its most basic, QE is essentially the creation of money and the injection of it into the economy. However it’s a little more complex than switching on the note presses and grabbing a wheel barrow.

The Bank of England injects the money into the economy by buying assets. This is intended to boost lending levels in commercial banks.

The last time the Bank of England launched a round of QE, £200bn was pumped into the economy. Of this, £198.3bn went into buying back government-issued debt, also known as gilts. It’s a fair bet to assume a majority of this £75bn of QE will again go into buying gilts.

The problem is these purchases push up the value of gilts and hence decrease their yield; that’s the cash heading back to those who have invested in the debt.

And unfortunately for retirees, pension funds are heavily invested in government bonds.

This is why the National Association of Pension Funds (NAPF) is warning that this latest round of QE could hit anyone with a pension scheme in the pocket.

Falling annuities

The NAPF are chiefly worried about the impact of QE on pension annuities (the product that takes your pension pot and turns it into a regular income). The income rate you receive from your annuity will depend – among other things – on current gilt return levels. If gilt interest rates drop, so does your annuity rate.

[SPOTLIGHT]The 2009 announcement of £200bn of QE quickly led to 18 providers cutting their annuity rates. And according to many pension insiders, this latest round of QE will likely have a similar impact.

To make matters worse, pension incomes on the whole are 30% lower than they were three years ago, according to the accountants PricewaterhouseCoopers

However, many retirees don’t do themselves any favours when picking an annuity.

Shopping around

As I reported last month, figures from the Association of British Insurers (ABI) show that only around 70% of retirees currently shop around when buying their annuity.

Part of the reason for this apathy among buyers is the tendency for pension providers to send out annuity application forms to customers nearing their retirement. This encourages buyers to purchase an annuity from their existing pension provider without shopping around.

Figures from the NAPF show that by not shopping around, retirees could receive just 75% of the income available from the market-leading annuity rate. That’s why it’s vital that you investigate all possible options fully when looking around for your annuity. And you can do this by using our new annuity calculator.

Take a look at Boost your pension by 40% for some more tips on jacking up your retirement income.

Inflation

Pensioners aren’t the only possible casualties of QE. In fact, if recent predictions concerning the impact of QE on inflation materialise, we could all lose out. Writing in the FT last week, Andrew Sentance – a former member of the MPC who continually voted to raise the base rate – said history teaches us that excessive QE produces long-term inflation and does little to support growth.

With the rate of Retail Prices Index inflation currently sat at 5.2%, we should all be hoping that Mr Sentance’s predictions turn out to be wrong.

To make matters worse, there are currently precious few savings accounts that offer an inflation-beating interest rate. As we reported earlier this week, the Post Office has now re-introduced its inflation linked savings bond. However you will have to lock your savings away for five years to get the best rate on this new account.

If you don’t fancy stashing your cash away for this length of time, your best bet is to pick up a standard fixed rate or easy access savings bond. No, they won’t keep you ahead of inflation, but at least you’ll be getting some return on your nest-egg. Take a look at these top accounts:

Source: lovemoney.com savings centre.

So as you can see, there’s not a vast difference in rates between the market-leading easy access account from Nationwide (3.12% AER) and the three-year bond rates (3.75%). Indeed, you may be better off plumping for an easy access account, waiting for the base rate to rise and then shifting your cash to a new account when the savings market starts to improve.

But remember, most easy access savings accounts come with a bonus rate that will drop away after 12 months, leaving you with a paltry return. So if you want to continue to get the best possible easy access rate on your savings, you should keep switching deals.

Your verdict

Do the possible negative impacts of QE outweigh any potential gains?

Let us know using the comment box below.

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