I’m 63 and looking to start drawing down from my pension soon. I have read about rising gilt yields and uncertainty in the stock market in the news and I am wondering if this will likely have any impact on my pension, and whether it should mean any change to my investments? Should I be concerned?

Malik, Stockport

Tom Selby, AJ Bell Head of Retirement Policy, says:

Let’s tackle the main bit of jargon in your question first – ‘gilt yields’. A ‘gilt’ is an IOU from the UK government. Investors in gilts, often large institutions or big pension funds, will pay a price for the gilt on the promise of receiving a certain interest rate (or ‘coupon’) each year until the end of the agreed period of time (‘maturity’).

The ‘yield’ on a gilt is simply the coupon paid by the gilt divided by the price, expressed as a percentage. For example, if a gilt is priced at £100 and the coupon is £5, the yield is 5%. That means when gilt prices go down, as we have seen in the last 12-18 months, gilt yields go up.

If you are in a defined contribution (DC) pension, whether or not this drop in gilt prices will impact you will depend on the extent your fund is invested in gilts and how far away from retirement you are.

FOR MOST THE IMPACT OF RISING GILT YIELDS SHOULD BE NEGLIGIBLE

The majority of people with a DC pension will be invested in a broad range of globally diversified assets. As such, the impact of short-term movements in gilt prices should be negligible. Equally, in most cases a short-term dip in investment performance should not be a big concern because investing is a long-term game.

Provided you are comfortable with the risks you are taking and focused on those long-term goals, you should be able to ride out any short-term bumps in the road. There is also the danger that if you sell your investments when they go south, you will effectively be crystallising that loss.

Those most impacted by a general drop in gilt prices will be people approaching retirement who have a substantial proportion of their fund invested in those gilts. That will primarily be people in ‘annuity hedging’ or ‘lifestyling’ investment strategies, which are based around the assumption you are going to buy an annuity (a guaranteed income for life sold by an insurance company).

If you are in one of these funds and still plan to buy an annuity, the drop in gilt prices should not be a problem because your investments are set up as a hedge against annuity rate changes. This is because, in simple terms, when gilt prices go down, annuity rates tend to go up. This should, in theory, mean the guaranteed income your fund will deliver remains fairly static as you approach your chosen retirement date.

However, the issue comes where someone is invested in one of these funds but no longer plans to buy an annuity. In these circumstances, you might have seen your fund value drop by 30% or more, but with no corresponding rise in the income your fund could produce.

IT’S CRUCIAL TO ENGAGE WITH YOUR PENSIONS

This is a clear example of why it is so important to engage with your pensions, particularly as you approach the point where you plan to take an income from your fund.

For those in this specific position, the most obvious options are:

– Remain invested in gilts and hope prices recover (no guarantee when this will happen);

– Buy an annuity instead (although this may not be appealing to those who are younger and prefer flexibility);

– Shift to a strategy more appropriate to your retirement income plans.

Conversely, if you are risk-averse or planning to access your fund soon, investing in gilts or other cash-like instruments, taking advantage of the high returns on offer might be attractive. Five of the 10 most popular investments made by AJ Bell’s DIY investors in September were government gilts.

Gilt yields also have an impact on defined benefit (DB) schemes, but again this is not something that should overly concern members. Broadly speaking, when gilt yields go up, DB liabilities (the estimate of how much it will cost the scheme to pay pensions to all its members) go down – and vice versa.

This means that, in terms of a scheme’s funding position, higher gilt yields should be good news (and lower gilt yields bad news). However, in the wake of last year’s mini-Budget, the dramatic spike in gilt yields resulted in a huge cash call from complex hedging instruments (Liability Driven Investments or ‘LDIs’) held by many DB schemes.

Although this led to lots of ‘pensions crisis’ headlines, in reality there was no direct impact on most people’s pensions. Provided the employer standing behind your DB scheme remained solvent, you should still receive the pension you were promised. And even where an employer sponsoring a DB scheme goes bankrupt, the Pension Protection Fund (PPF) provides a valuable compensation lifeboat, paying out at least 90% of your promised pension (although you may lose some inflation protection).

Disclaimer: Financial services company AJ Bell referenced in the article owns Shares magazine. The author of the article (Tom Selby) and the editor of the article (Tom Sieber) own shares in AJ Bell

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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